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By Scott Burns | 03-30-2011 04:47 PM

Sizing Up the First Bank Loan ETF

Morningstar ETF analyst Tim Strauts explains the strategy behind the PowerShares Senior Loan Portfolio ETF and what potential bank-loan investors should consider before jumping aboard.

Scott Burns: ETFs expand in the variable fixed income market.

Hi there, I'm Morningstar's director of ETF research, Scott Burns. Joining me today is analyst Tim Strauts.

So, Tim, we've had a new launch from the PowerShares group into the bank loan market. Before we talk about the fund specifically, let's talk a little bit about bank loans and how they differ from probably what investors are really used to when they look at fixed-income and fixed-income funds.

Timothy Strauts: Sure. The bank loan space, the first key difference we want to look at is the name, bank loans. It's not bank bonds; it's bank loans. So, these are not actually securities. They are actually loans. Originally in the '80s and '90s, they were given out by commercial banks and now the loans are given out by fund companies, but they are just loans.

Burns: Right. So, you are not lending money to the bank. These are loans that have been originated by the bank, have been securitized, and then are now out there. So, a General Motors would have a loan and a Procter & Gamble would have a loan, et cetera?

Strauts: That is all true, except for that they are not securitized.

Burns: They are not securitized...

Strauts: That's the one key thing. The other thing that's interesting about them is that they have floating rates. The interest rates on these loans adjust every 30 to 90 days based on a benchmark rate, which is usually the LIBOR rate--the London Interbank Rate.

Burns: So the LIBOR rate, which is probably unfamiliar to a lot of investors, that's very common parlance in the corporate banking space. It floats, it's the money that banks charge each other to lend money back and forth, so it is a floating rate, but it is different than, say prime, correct?

Strauts: Yes, it is different and will adjust differently. So these rates are all LIBOR plus something, LIBOR plus 2, LIBOR plus 3.

Burns: Right. So, why would an investor want a floating rate security, a floating interest rate? I think people are really used to, I have my coupon, I clip it, and that's the fixed rate. But this, the coupon rate on a month-to-month basis, it could be 5%, it could be 3%; it's going to move with that interest rate and the spread is what will maintain, right?

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