Leveraged Loan ETFs in Canada Boost Defenses in Case of Selloff

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Canadian exchange-traded funds that buy leveraged-loans are shoring up defenses against a sudden flight by investors.

The Horizons Senior Loan ETF received approval from the Ontario Securities Commission to boost borrowing limits to help meet potential redemptions in an asset class where it can take as long as 20 days to close a trade. First Trust Advisors, which manages the largest loan ETF in Canada, is seeking similar permission from authorities, according to Bill Housey, who manages that fund.

“We put this in place due to the potential timing issues around settlement of senior loans,” Steven Hawkins, co-chief executive officer of the Horizon ETF, said in a telephone interview. “The manual process of signatures, couriers and faxing is just mind-boggling. It’s an unfortunate fact of the current market.”

The fund is now allowed to borrow as much as 10 percent relative to its assets compared with a previous limit of five percent, according to Hawkins.

The fund initially asked the regulator to permit it to borrow as much as 30 percent of its assets, similar to standards in the U.S. The Horizons loan ETF has a market capitalization of C$44 million ($35.7 million).

Regulators are increasingly paying attention to funds that buy hard-to-sell assets, Securities and Exchange Commissioner Kara Stein said in a speech in Washington on Monday. And they should question whether retail investors can understand the risks of investing in funds that hold assets such as leveraged-loans.

“Settlement Cycle”

Loan-settlement times lag behind other investments as the industry continues to rely on faxes for some of its business.

“Solely due to the settlement cycle, we may need to borrow funds to facilitate redemptions,” said Hawkins.

First Trust’s Canadian loan ETF has a market capitalization of C$100 million and has a similar $293 million fund in the U.S.

The firm increased its credit line for its U.S. funds to $80 million at the end of last year from $20 million in 2013. The line can finance redemptions at a number of its U.S. funds, including the loan ETF, Housey said.

Loan Outflows

Loan funds have reported the biggest outflows this year among fixed-income asset classes tracked by Bank of America Corp. Investors pulled $6.9 billion from the floating-rate debt, or 4.9 percent of total assets, according to a June 11 report, from the Charlotte, North Carolina-based bank.

Invesco Ltd.’s PowerShares Senior Loan fund, the biggest ETF purchasing speculative-grade corporate loans, has seen its market capitalization shrink by more than 22 percent in the last year to $5.6 billion, according to data compiled by Bloomberg.

Jeaneen Terrio, a spokeswoman for Invesco, declined to comment when asked if the firm is taking any steps to protect against redemptions for a similar fund in Canada.

“It’s a sensible thing to do,” Housey said. “You want to put in place as many levers as possible to pull in a challenging environment.”

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