Investors today are faced with two significant challenges in fixed income:
In this piece, we will discuss how senior loans may offer a strong solution to each of these challenges.
When investing in fixed income, investors must consider both credit risk and interest rate risk. Rising interest rates can have just as harmful an impact on fixed income portfolios as credit risk. Investing for income while not losing principal in a rising rate environment can be challenging, but senior loans may help fixed income investors achieve their investment objectives in a wide variety of market conditions. That is especially true in a rising rate environment because of their high relative yields and limited exposure to interest rate risk due to their short duration.
The U.S. Federal Reserve (the Fed) policymakers are widely expected to raise interest rates three to four times this year, starting as early as March. The Invesco Global Senior Loan team believes investors should consider repositioning their fixed income portfolios to better prepare for rising rates. Structurally, senior loans pay interest based on floating rates, so loans have significantly much less duration (or interest rate risk) than many fixed income categories.
Source: Senior loans represented by the the Credit Suisse Leveraged Loan Index (CS LLI) (outsized return in 2008-2009 period was 44%, edited for scale), IG Corporates represented by the Bloomberg U.S. Corporate Bond Index, U.S. Aggregate represented by the Bloomberg U.S. Aggregate Bond index, 10 Year Treasury represented by the FTSE 10-Year Treasury Benchmark Index.
Past performance is not a guarantee of future results. An investment cannot be made into an index.
Even if the widely expected Fed rate hikes are surprisingly fewer or postponed, we believe the high levels of income typically produced by senior loans should keep them competitive in terms of total return prospects for 2022, relative to other fixed income categories.
The senior loan market, like any other capital market, is subject to a certain amount of price volatility based on investor sentiment, technical factors of supply and demand, and/or valuations. Yet, because senior loans sit atop a company’s capital structure and are secured by the company’s assets, they can be an effective tool for delivering income generation and capital preservation objectives. We believe senior loans should be a core allocation in all fixed income portfolios and, for the reasons cited above, we believe senior loans may be an especially appealing option for 2022.
Source: Barclays, JP Morgan, Credit Suisse, and Bloomberg L.P. as of December 31, 2021. Bloomberg U.S. Corporate Bond index represents IG corporates, the JPM U.S. HY index represents High Yield and Credit Suisse Leveraged Loan Index (CS LLI) represents the Leveraged Loans. Loan Yields represented yield to 3 year.
Past performance is not a guarantee of future results. An investment cannot be made into an index.
Senior loans may deliver several compelling characteristics that can make them an attractive long-term core holding in fixed income portfolios in various environments. In today’s market environment, two of those characteristics are particularly relevant:
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Important information
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Some references are U.S. centric and may not apply to Canada.
There is a risk that the value of the collateral required on investments in senior secured floating rate loans and debt securities may not be sufficient to cover the amount owed, may be found invalid, may be used to pay other outstanding obligations of the borrower or may be difficult to liquidate.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
All investing involves risk, including the risk of loss.
The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market.
The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the intermediate-term investment grade, U.S. dollar-denominated, fixed-rate taxable bond market.
The Barclays U.S. Investment Grade Credit Index measures the investment grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related bond markets.
The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar - denominated leveraged loan markets
The JPMorgan U.S. High Yield Index is an unmanaged index that tracks the performance of U.S. dollar denominated, below investment-grade rated corporate debt publicly issued in the U.S. domestic market.
The FTSE 10-Year Treasury Benchmark Index measures total returns for the 10-year U.S. Treasuries that settle by the end of the calendar month.
The opinions referenced above are those of the author as of Jan. 25, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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