May 11, 2022

State Street ETF scored powerfully in 2021 by asking Blackstone to sub-advise ‘esoteric’ lending; now State Street is launching a new ETF and rewarding Blackstone with a longer leash to seek higher returns

The $881 billion Manhattan alternative investor will dive into junk on top of safer senior loans with a new ETF. No one will complain about the 70 basis point fee, if they again offer higher yields and the inflation protection of floating interest rate loans.

State Street Global Advisors (SSGA) gave Blackstone a short leash to generate higher bond yields in 2013 – with great success in 2021.

Now SSGA is extending the lease this year to let Blackstone chase even higher yields with a new product that includes junk bonds in its portfolios.

Daniel McMullen: “We see an attractive opportunity to generate income in high yield corporate bonds.

The $4 trillion asset management Boston arm of State Street Corp. (NYSE: STT) Launches SPDR Blackstone High Income ETF (HYBL)

Wall Street sub-advisor Blackstone Credit will have the leeway to ease a little more after eight years of restrictions.

“We are very pleased to release this,” said Sue Thompson, head of SPDR Americas distribution at State Street Global Advisors in an interview from her base in Phoenix.

High-yield bonds, or “junk” bonds, pay higher interest rates because they have lower credit ratings than investment-grade bonds, namely those rated below BBB- by S&P, or in below Baa3 on the Moody’s scale.

cut in

The HYBL fund’s holdings largely straddle the C and B lines, resulting in a healthy return of more than 5%, according to the State Street website.

The State Street sub-advisor sits just above the junk quality level. (Click on the image to enlarge it).

The current US federal prime rate is 3.25%. Money market funds currently pay an insulting annual average of 40 basis points.

T. Rowe Price made the extraordinary decision to acquire Oak Hill Partners for $4.2 billion to increase returns and profit margins. See: T. Rowe Price strikes $4.2 billion whirlwind deal to become ‘alternative credit’ leader by delivering deep cash at close and promising light touch

Even Vanguard Group has openly sought higher returns on behalf of investors – and cut itself with healthy fees. See: ‘Late’ Vanguard joins crowd selling ultra-short, human-run bond ETFs after money markets refuse to rebound

The yield on the US 10-year Treasury has risen from 1.63% to 1.97% or 21% since the start of the year, according to data published by Brad McMillan, Chief Investment Officer for Commonwealth Financial Network.

It’s a big step forward, but still a pittance in absolute terms.

“As investors seek higher yields, demand for senior loans and high-yield corporate bonds is on the rise,” Thompson said in a statement.

Rising rates

SSGA’s expanded mandate at the $881 billion New York City alternatives manager follows the launch of the SPDR Blackstone Senior Loan ETF (SRLN).

Brad Marshall, Blackstone
Brad Marshall: “We’ve talked all year about how good it is to be in variable rate senior secured loans.”

It added $6.7 billion in assets under management in 2021 – the largest inflows of any actively managed ETF last year.

Blackstone Credit’s proprietary private credit fund also had a terrific year, hitting $33 billion in 12 months.

“We’ve been talking all year about the quality of floating rate senior secured lending in an inflationary and rising rate environment,” Brad Marshall, head of private credit at Blackstone in North America, told Barron’s.

“Then, boom, in January, we really saw that come into play.”

Esoteric loan

The variable-rate aspect of Senior Loans is underappreciated, says Thompson.

“You could get a higher rate and it’s a floating rate so you don’t get hit [by inflation],” she says.

Senior loans are an area where active management is generally more conservative than index investing, Thompson says — a reality advisers appreciate.

“A lot of clients are very familiar with fixed income,” she says. “But the esotericism of senior loans is not their forte.”

Blackstone’s strength is the esotericism of credit investing, says Dan McMullen, head of North American liquid portfolio management for Blackstone.

“We see an attractive opportunity to generate income in high yield corporate bonds, senior loans and CLO debt securities through our active management approach,” he said in a statement.

“HYBL will build on the proven track record we have established through SRLN with State Street and benefit from our deep expertise in credit investing.”

Risk of seduction

Thompson notes that State Street’s willingness to hire third-party expertise in many cases gives it an advantage over, for example, BlackRock (his former employer) which handles investments in-house.

SRLN’s total assets now stand at $9.9 billion, according to Morningstar, and its yield is around 4.18%. Both SRLN and HYBL charge a fee of 70 basis points. HYBL has approximately $127 million in assets days after launch.

The new SSGA-Blackstone product, HYBL, takes on more risk than SRLN to get a better return – currently around 100 basis points more.

As sub-advisor to HYBL, Blackstone will actively manage a diversified portfolio of high yield corporate bonds, senior loans and debt tranches of US secured loan obligations (CLO) – a single security backed by a pool of debt, typically business loans with low credit ratings.

“The only free lunch in investing is diversification and that’s the case here,” says Thompson.