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Can Senior Loans Help A Pension Plan?

Highlights

  • Today’s low interest rate environment is a challenge for many plan sponsors.
  • Rates are likely to rise as economic recovery continues.
  • Allocations to senior loans may be a solution to low yields and rising rates.

Pension funds are in a pickle and interest rates on perceived “safe” bonds are at or near historical lows as the result of quantitative easing. The current low yields on high grade fixed income assets limit returns just as they boost the present value of future liabilities. Liability Driven Investing (LDI) holds out the mathematical prospect that pension liabilities can be immunized thus reducing the impact of shortfalls on corporate balance sheets. For many, LDI is an aspiration not easily realized in the current rate environment, and they may necessitate higher yields in order to engage in partial – or full – LDI. Whatever the perceived strategy, the impact of shortfalls on corporations and shareholders may be huge.

Are there asset classes that may provide tactical benefits as we wait for the likely rise in interest rates? We believe that senior, or leveraged, loans might bridge the gap for not only pension funds contemplating LDI in the future, but also investors that are hamstrung by the low yields and high duration risk of their traditional bond allocation today. Senior loans have considerably less interest rate risk than most fixed rate bonds since the coupons on most senior loans reset to the London InterBank Offered Rate (LIBOR) quarterly. Additionally, the low historical correlation of loans to other asset classes utilized by institutional investors may enhance a portfolio’s overall diversification. Of course, diversification does not guarantee profit or protect against loss.

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London InterBank Offered Rate (LIBOR) is the rate at which banks loan each other money in the London wholesale money market.

Special Risks Fixed income investing entails credit risks and interest rate risks. When interest rates rise bond prices generally fall and a fund’s share prices can fall. Senior loans are typically lower rated (more at risk of default) and may be illiquid investments (which may not have a ready market).

These views represent the opinions of OppenheimerFunds and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the open of business on October 14, 2013, and are subject to change based on subsequent developments.

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