In the following paper, we explain the four primary reasons why we believe investors should avoid passively managed exchange traded funds (ETFs) in the loan category.
- They’re Not Cheap
Loan ETF fees are multiples higher than ETF fees in other popular investment categories and nearly as much as the fees on active strategies.
- Tail Risk
The ability for active managers to avoid lending to companies in dying industries― thereby avoiding significant tail risk―is a distinct advantage for active managers in the loan category.
Passive loan ETFs have historically underperformed some of the top actively managed funds in the Morningstar Bank Loan category.
To provide the liquidity levels demanded by ETF investors, passive managers must make significant compromises to squeeze loans into an ETF structure. The compromises made in creating a loan ETF can lead to it not really offering representative exposure to the broad loan market.
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Tail Risk: Tail risk is a form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution. Tail risks include events that have a small probability of occurring and occur at the end of a normal distribution curve.
Correlation: Correlation expresses the strength of relationship between distribution of returns between two data series. Correlation is always between +1 and -1, with a correlation of +1 expressing a perfect correlation, meaning that the two series being compared behave exactly the same, a correlation of -1 meaning the two series behave exactly opposite and a correlation of zero meaning movements between the two series are random. There are no guarantees that the historical performance of an investment, portfolio or asset class will have a direct correlation with its future performance.
Mutual funds are subject to market risk and volatility. Shares may gain or lose value.
Senior loans are typically lower rated and may be illiquid investments (which may not have a ready market). Fixed income investing entails credit and interest rate risks. When interest rates rise, bond prices generally fall, and a fund’s share prices can fall.
These views represent the opinions of the Portfolio Managers at OppenheimerFunds and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.