First Trust Advisors, a global provider of exchange-traded funds (ETFs), has rolled out its fourth actively managed ETF. Listed on the Nasdaq exchange, the First Trust Senior Loan ETF (FTSL) seeks to generate high current income and preserve capital by investing primarily in a diversified portfolio of first-lien senior floating-rate bank loans.

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While the vast majority of ETFs are passive index trackers, the fund’s active management approach enables it to potentially obtain superior risk-adjusted returns over time in what is arguably a less efficiently priced asset class.

Under normal market conditions, at least 80% of the fund’s net assets will be invested in senior loans made to businesses operating in North America. Up to 20% may be allocated to non-senior loan debt securities, equity securities and warrants.

The fund attempts to outperform both the S&P/LSTA US Leveraged Loan 100 Index and the Markit iBoxx USD Leveraged Loan Index.

William Housey, Senior Portfolio Manager at First Trust, said: “While an index-based senior loan ETF principally considers the market value of the debt issuance outstanding in its selection methodology, an actively managed ETF gives us the latitude to utilise our rigorous credit process in evaluating an individual company’s ability to repay its debt, which we believe is paramount to driving attractive risk-adjusted and absolute returns over the long term.”

He added: “Many fixed-income investors are looking for alternative sources of income that have historically performed well when interest rates have increased, such as senior loans, and we believe an actively managed ETF is an ideal way for investors to access a diversified portfolio of senior loans while gaining enhanced transparency and liquidity.”

Senior loans are generally made to below-investment-grade companies, and are secured by collateral of the issuing company and positioned at the top of the capital structure. In addition, senior loans have interest rates that reset every 30 to 90 days. This “floating rate” feature sets senior loans apart from high-yield bonds and other fixed-rate bonds, as senior loans may generate higher levels of income as short-term interest rates increase.

Senior loans’ secured position within a capital structure can mitigate losses in the event of a default. According to Moody’s, the average recovery rate for senior loans between 1987 and 2012 was 80.6%, compared to 63.7% for senior secured bonds, 48.6% for senior unsecured bonds and 28.5% for subordinated bonds.

First Trust argues that due to senior loans’ impressive recovery rate, lower sensitivity to rising interest rates, and their historically low correlations to other fixed-income asset classes, senior loans can potentially decrease volatility and improve risk-adjusted returns for a well-diversified portfolio.

“While nobody knows exactly when interest rates will climb up from today’s historic lows, we believe such an increase, when it occurs, can be devastating to a traditional fixed-income portfolio,” continued Housey. “The First Trust Senior Loan Fund is unique because it offers investors an opportunity to capitalise on the relatively attractive yield from senior loans while simultaneously providing a degree of protection from the harmful effects of a potential increase in interest rates.”

The fund’s closest rival is the recently launched SPDR Blackstone / GSO Senior Loan ETF (SRLN). This NYSE Arca-listed fund is also actively managed and benchmarked against the same S&P/LSTA and Markit iBoxx indices. Since its debut last month, it has accumulated assets of more than $160 million.

Passively managed alternatives include the Highland iBoxx Senior Loan ETF (SNLN) and the PowerShares Senior Loan Portfolio ETF (BKLN), both listed on the NYSE Arca.

As yet, no senior loan ETFs are available to UK/European investors on local exchanges.