Bank Loans: We've Been Here Before
BANK LOANS ARE NEAR PAR—HAVE THEY LOST THEIR VALUE?
Bank loans generated a solid return of 4.25% in 2017, as measured by the Credit Suisse Leveraged Loan Index, and are off to a good start in 2018, posting a positive 1.26% return through February 2018. The loan market is demonstrating its resilience to the rising interest rate environment that is negatively impacting fixed-rate asset classes. Given strong demand, bank loan prices have moved near to par (face value), yet in our view, the loan sector remains attractive. At current levels, loans still offer healthy risk-adjusted yields in a low default rate environment, relative to other corporate credit sectors. Just as important, we point to similar periods in time as a guide to put today’s loan market valuation in historic perspective. It is our view that the strategic reasons to own bank loans as part of a fixed income portfolio remain intact: potential interest rate hedge, investment secured by collateral, low correlation to other fixed income asset classes, and income.
Many investors are adding bank loans to their portfolios as a preemptive measure against the impact of a rise in short-term interest rates. Bank loans pay a floating rate that is reset every 90 days to the 3-month LIBOR (London Interbank Offered Rate). When rates rise, the loan coupon rises, thus significantly reducing the risk tied to interest rate moves. Traditional fixed income securities are more interest-rate sensitive.