Loan Market Observations
After 95 straight weeks of retail inflows into the floating rate loan asset class, the loan market has experienced two weeks of redemptions from retail investors. The shift, coupled with an increase in the supply of new issuance, has created a slight weakness in loan prices that could persist for the short term. Importantly, there is no change in loan credit fundamentals, which remain healthy.
The recent shift is largely driven by many investors who already have an allocation to the loan asset class (so there are fewer investors to allocate new money), and the tightening of Treasury rates to start the year. With Treasuries not widening as many anticipated, the threat of rising rates is marginally less important in investors’ eyes in the near term, and hence, the loan market has become less attractive or necessary.
In our view, investors who redeem now are losing sight of the long-term strategic rationale of the floating rate loan asset class, which remains solidly intact. Specifically:
- Loans continue to be a natural hedge against rising rates. While rates (both long and short) have not yet increased, it is prudent to manage rate risk within a fixed income portfolio.
- Downside protection created by loan seniority and collateral can assist in managing credit risk.
- Correlation of loans to traditional fixed income asset classes remains low (in fact, loans are negatively correlated to U.S. Treasuries), adding diversification.
- Loan yields, while lower than a year ago, remain attractive, especially in relation to other fixed income classes currently.
Loans continue to be well positioned as an interest rate mitigation tool, as well as for providing current yield. We are still calling for full-year total return to be largely the coupon (4% area). With the investment thesis intact, it is our view that investors may wish to consider an allocation to the loan asset class.
Bank Loan Risks: Debt securities are subject to various risks, the most prominent of which are credit and interest rate risk. The issuer of a security may fail to make payments in a timely manner. Values of debt securities may rise and fall in response to changes in interest rates. This risk may be enhanced with longer-term maturities. There may be no ready market for loan participation interests. The fund may have to sell the interests at a substantial discount. Such interests are subject to the credit risk of the underlying corporate borrower. There is a greater level of credit risk and price volatility involved with high yield securities than investment grade securities. When a fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded. Certain securities may be difficult to sell at a time and price beneficial to the fund.
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