Senior secured loans investment insights
Key takeaways
Investors are facing growing challenges in the current capital market environment. These are characterized by a mix of compressed risk premiums, low-yielding ‘safe-haven’ investments, high inflation and heightened volatility.
Due to low yields on high-quality government bonds, actuarial discount rates — used to value future pension liabilities — have also decreased. This has caused the present value of future pension liabilities to increase significantly. This growth in liabilities and their increasing volatility forces institutional investors to consider new asset allocation strategies.
Many of the most commonly used fixed income investments, such as high-quality government bonds, now generate negative real returns, considering the currently high levels of inflation. Consequently, modified durations of these investments have reached all-time highs, posing significant duration risk to investment portfolios.
With base rates across G7 countries either negative or at historical lows, and the removal of monetary and fiscal stimulus, forward rate and inflation expectations have started to rise. The US Federal Reserve (Fed) hiked rates for the first time in March and market expectations seem to be moving ever higher as the central bank signalled an aggressive fight with inflation.
We believe the current uncertain market environment calls for fundamental changes in asset allocation in order to meet long-term real return targets.
We favour a fixed income allocation that enables
- a flexible response to future interest rate movements, and
- attractive yields in a low yield environment.
We believe senior secured loans (SSL) offer features that may meet the needs of investors:
- Attractive current income — independent from market environment
- Minimal duration risk — providing a hedge against rising interest rates and inflation
- Historic record of low volatility of investment returns compared to traditional asset classes
- Strong historic and current risk-adjusted return profile
- Implied comprehensive credit risk mitigation mechanisms
- Low historical correlation of returns providing potential portfolio diversification benefits
This paper looks to provide a detailed introduction to the asset class and takes a deep dive into some of the features listed above. We also have a Q&A with Invesco’s Kevin Petrovcik, senior client portfolio manager at our global bank loans business.
