A Compelling Case for Leveraged Loans
In the current market environment, there are a number of compelling reasons to invest in leveraged loans.
In a situation where most assets are trading near historically high levels, loans remain attractive on a risk-adjusted basis compared to other asset classes. In particular, the senior position of loans within the capital structure helps to mitigate risk.
Leveraged loan fundamentals generally are positive. For the issuer universe overall, debt service metrics are strong and defaults have been lower than the historical average (please see Exhibit 3 on page 3). Furthermore, steady economic growth in the U.S. and other favorable indicators may provide a supportive backdrop.
Technical conditions – supply and demand – are in balance and provide further support to the leveraged loan market. Issuance hit record-high levels in 2017 while strong demand driven by the collateralized loan obligation market (CLO) has offset softer retail flows.
In a rising interest rate environment, such as the present time, leveraged loans may provide some protection against rising rates. As a floating-rate product, coupon rates on leveraged loans typically reset every 90 days. Unlike conventional fixed income assets, loan prices are unlikely to fall when interest rates climb. All else being equal, rising rates could be a tailwind for leveraged loans and a headwind for other asset classes.
IMPORTANT RISK CONSIDERATIONS
Bank Loans: Loans may be unsecured or not fully collateralized, may be subject to restrictions on resale and/or trade infrequently on the secondary market. Loans can carry significant credit and call risk, can be difficult to value and have longer settlement times than other investments, which can make loans relatively illiquid at times. Credit & Interest: Debt securities are subject to various risks, the most prominent of which are credit and interest rate risk. The issuer of a debt security may fail to make interest and/or principal payments. Values of debt securities may rise or fall in response to changes in interest rates, and this risk may be enhanced with longer-term maturities. Foreign & Emerging Markets: Investing internationally, especially in emerging markets, involves additional risks such as currency, political, accounting, economic, and market risk. High Yield-High Risk Fixed Income Securities: There is a greater level of credit risk and price volatility involved with high yield securities than investment grade securities.