Tidal Financial Group has launched a new actively managed fixed income ETF investing primarily in senior secured debt.
Tim Gramatovich, Founder of Gateway Credit Partners.
The Senior Secured Credit Opportunities ETF (SECD US) has been listed on NYSE Arca with an expense ratio of 0.95%.
The fund is sub-advised by Gateway Credit Partners, a value-based credit manager focused on capturing both fundamental and technical inefficiencies in the leveraged loan and high yield bond market.
Senior loans refer to loans made by financial institutions to companies that are generally considered to have low credit quality. They have greater seniority in an issuer’s capital structure, taking priority over other unsecured or otherwise more junior debt, and are often directly backed by underlying collateral.
Many senior loans are structured with floating-rate coupons that adjust to reflect changes in interest rates. Compared to traditional bonds which pay fixed coupons, this feature makes floating-rate securities far less susceptible to losing value when interest rates increase.
Due to the inherent characteristics of senior loans, the ETF may appeal to yield-hungry investors who are concerned about duration risk and wish to have less exposure to downside risk compared to high-yield bonds – according to Moody’s, in the event of issuer default, the recovery rate of senior loans is approximately 60% compared to 40% for high-yield bonds.
Senior loans have also historically exhibited a relatively low correlation to core fixed income sectors, such as investment-grade bonds and sovereign debt, and a higher correlation to inflation, making them a powerful diversifier for traditional bond portfolios.
Investment approach
The ETF focuses on US dollar-denominated, first-lien senior secured loans made to companies domiciled in North America. The portfolio comprises between 50 to 100 loans with a target allocation of 1-2% to any specific company.
Gateway’s investment thesis seeks to exploit a “size arbitrage” that the firm believes exists in credit markets due to rating agencies over-emphasizing size (based on revenues and market capitalization) compared to credit fundamentals. Gateway’s fundamental investment process seeks out companies exhibiting low leverage, the ability to generate true free cash flow, excess liquidity, and a business model that can withstand significant revenue reductions in downside scenarios.
Commenting on the current state of the senior loans market, Tim Gramatovich, Founder of Gateway Credit Partners, said: “After almost 13 years of a 0% interest rate policy, fixed income investors have an environment where meaningful yields now exist. At over $3 trillion, the US loan and high yield bond markets offer investors a tremendous opportunity to generate yield. We believe SECD fills a much-needed gap in the actively managed corporate credit space particularly as it relates to the loan market which has been the purview of CLOs and index products with very little in the way of true fundamental credit work.”
Gramatovich added: “We view the secondary loan market as very large and inefficient and ripe for generating both significant income and potential capital gains for investors. The key to success here is avoiding what we call ‘stretch’ first-liens or massively over-levered loans further challenged with fictional accounting metrics known as ‘pro-forma further adjusted EBITDA’.”