Bank Loans Have Been Looking More Attractive to High-Yield Investors
August 29, 2019
Historically, bank loans have offered high income with very little duration and historically attractive risk-adjusted returns.
By Michael Felz, CFA, Product Consultant
Despite ongoing technical pressures in the space as a result of falling interest rates, we believe loans remain an attractive asset class in the current environment. Bank loans should not be just a tactical call on rates; typically, the asset class has offered high income with very little duration and historically attractive risk-adjusted returns. Moreover, bank loans have been negatively correlated with core bonds, providing the added benefit of diversification to core bond portfolios by potentially lowering the risk of holding core bonds on their own.
Today, high-yield bond investors might want to consider adding bank loans to their fixed-income portfolios as well, not only to reap the potential benefits of the current market—in which bank loans have offered higher average yields and wider spreads than high-yield bonds—but also to capture the potential for outperformance 12 months from now.
Chart 1. Historically, in Recent Periods When Loan Spreads were Above High-Yield Spreads, Loans Outperformed Over the Following 12 Months Forward 12 month return difference: loans – high-yield bonds (December 31, 2013–August 31, 2018) and spread difference: loans to high-yield bonds (December 31, 2013–June 30, 2019)*
Source: Loans = Credit Suisse Leveraged Loan Index (discount margin). High Yield = ICE BofAML US High Yield Constrained Index (spread to worst).*All data most recent available. Past performance is not a reliable indicator or guarantee of future results. Due to market volatility, the asset classes depicted in this chart may not perform in a similar manner in the future. For illustrated purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
While past performance offers no promise of future performance, we believe bank loans are an attractive asset class that investors may want to consider adding to their fixed-income portfolios.
A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As interest rates rise, the prices of debt securities tend to fall. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Lower-rated bonds carry greater risks than higher-rated bonds. The principal risks associated with bank loans are credit quality, market liquidity, default risk and price volatility. While bank loans are secured by collateral and considered senior in the capital structure, the issuing companies are often rated below investment grade and may carry higher risk of default. Moreover, the specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer maturity of a security, the greater the effect a change in interest rates is likely to have on its price. No investing strategy can overcome all market volatility or guarantee future results.
Neither diversification nor asset allocation can guarantee a profit or protect against loss in declining markets.
There is no guarantee that the floating-rate loan market will perform in a similar manner under similar conditions in the future.
Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described above.
Any examples provided are for informational purposes only and are not intended to be reflective of actual results.
A discount margin (DM) is the average expected return earned in addition to the index underlying, or reference rate of, the floating rate security.
Spread-to-worst is the difference between the yield-to-worst of a bond and yield-to-worst of a U.S. Treasury security with a similar duration. The yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting.
The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market.
The ICE BofAML U.S. High Yield Constrained Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD, ABBETT & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.