
Senior secured loans
Kevin Petrovcik shares his thoughts.
Although there has been significant volatility across financial markets, we believe there’s continued opportunity for alternative investments.
Our senior loan and real estate teams reflect on the year so far and share their thoughts on what lies ahead. Plus, we take a look at what’s happening in the gold market.
Senior secured loans
Kevin Petrovcik shares his thoughts.
Despite the rise in investor concern over inflation risk, geopolitical turmoil in Ukraine, and the recent risk-off environment, the loan market has held up remarkably well relative to many other asset classes in 2022. Figure 1 details the year-to-date performance for various asset classes.
Asset class |
YTD return (%) |
---|---|
DJIA |
-12.10 |
S&P 500 |
-17.11 |
Russell 2000 |
-22.23 |
MSCI EM |
-19.27 |
US High Yield |
-9.65 |
European High yield |
-8.51 |
US Leveraged Loans |
-2.33 |
European Leveraged Loans |
-2.04 |
Source: JP Morgan represents leveraged loans and high yield indices. S&P, Russell, and MSCI represent their respective indices. All data as of 13 May 2022.
Naturally, loans are not impervious to other movements in the broader market. During a risk-off environment, you tend to expect loan prices to move down in the short-term. However, we believe that loan market performance this year has demonstrated the resilient nature of the asset class.
Even though we have seen heightened volatility this year, our outlook remains positive. With rising rates one of the drivers of volatility, we are also buoyed by senior loans historically producing a high level of income in an inflationary, rising rate environment (Figure 2).
Source: Senior Loans represented by the CS LLI, IG Corporates represented by the Bloomberg US Corporate Bond Index, US Agg. represented by the Bloomberg US Aggregate Bond index, 10 Year Treasury represented by the FTSE 10-Year Treasury Benchmark Index. An investment cannot be made directly in an index.
In fact, we have been very focused on the risk of higher inflation. We began repositioning in Autumn 2021 with respect to companies that, in our view, did not have the ability to push through pricing increases to their customers because of inflationary pressure and potentially higher wages. In so doing, we have exited those positions that we believe are most susceptible to inflationary pressure.
With a recent indiscriminate sell-off, the market has also become more discerning of credit risk. The reassertion of rational credit analysis may continue as investors gain further clarity on the earnings impact and immediate cash flow risk facing companies.
Loan issuers are, by and large, earning EBITDA margins at or above pre-pandemic levels. They boasted interest coverage ratios with comfortable cushions to weather both increased interest expense and potentially lower EBITDA. The sturdy financial profile of loan issuers across the market is a key reason why the percentage of loans trading at distressed levels remains so low, despite ongoing macro uncertainty.
Along with the low distressed ratios, default rates remain at an all-time low, according to S&P, with rates of only 0.18% for the US and 0.64% for Europe (30 April 2022).
We believe that the low default rates and stable interest coverage ratios bode well for investors. We believe the fundamentals of senior loans remain positive with an attractive yield and strong return profile potentially available.
But any uncertainty could create dislocations between price and fundamental value. In our view, this may lead to some compelling opportunities for long-term investors with the resources to cover the entire market in depth.
Data is provided as at the dates shown, sourced from Invesco unless otherwise stated.
This is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only. It should not be relied upon as recommendations to buy or sell securities.
Where individuals or the business have expressed opinions, they are based on current market conditions. They may differ from those of other investment professionals. They are subject to change without notice and are not to be construed as investment advice.