Britain’s decision to leave the European Union (EU) has created considerable turmoil across global financial markets. The equity and currency markets have been hard hit and, in some countries, interest rates have turned negative.
Investors with the greatest concerns, of course, are those with direct exposure to European markets, and the British market in particular.
One asset class that can potentially offer some relief from the current turmoil is senior loans. Historically, senior loans are less volatile than equities, typically offer higher interest rates than government bonds, and have exposure predominantly to American companies. The leveraged loan market offers an opportunity for investors to lend to great American companies at the senior, secured level, and the potential to earn high yields with negligible currency risk.
Many Corporate Debt Issuers Primarily Serve the U.S. Market
In our view, the vast majority of corporate debt issuers that borrow in the leveraged loan market will experience little or no impact to their operational outlook as a result of Brexit. Most of these companies are based in the United States and their products and services are delivered to U.S. consumers.
Examples of corporate debt issuers that fit this profile include:
- Restaurants such as Burger King, Landry’s and Chuck E. Cheese.
- Healthcare providers such as Community Health, Pharmaceutical Product Development and Golden Living.
- Movie theaters such as Regal, AMC and Cinemark.
Americans are not going to stop eating, getting sick, going out on dates and having fun because Britain left the EU. Therefore, these businesses have little to fear in this way. A large preponderance of the issuers in the loan market fit a similar profile. They are domestic companies that serve domestic customers with fairly essential products and services. Other good examples include utilities (Calpine) that provide air conditioning and light, cable TV (Charter Communications) and broadcasters (Univision) that provide updates on things like Brexit, and consumer products companies (Hanesbrands) that provide goods as essential as underwear. Surely no one intends to go commando because of Brexit.
Despite what you’ll hear on the TV and in the papers over the next few days and weeks about the enormity of Britain’s decision, life will go on and business will go on―especially American business. This is not to minimize the importance of the referendum, which will cause numerous significant changes to business and politics globally, with consequences and repercussions for years to come. But it should be recognized that these changes are rather abstract now and will impact businesses slowly over time, not unlike the way technological or regulatory changes do, and companies have demonstrated a good ability to deal with change and adjust to it as appropriate.
A Minority of Loan Issuers Will Likely Be Affected
There are a few issuers in the loan market that may be impacted sooner and more directly than most. These potentially include commodity producers or industrial manufacturers with heavy exposure to Europe. These types of companies are a clear minority in the loan market. But even for these issuers, we believe the likely impact Brexit will bring is a relatively modest adjustment to their total enterprise value, which will be reflected in their stock price. But it is difficult to imagine that Brexit would bring a valuation change of a magnitude large enough to impact their ability to service their senior and secured debt.
Any Selloff Could Present an Opportunity
So while we do expect some heightened volatility and weaker sentiment in the loan market in sympathy with global equities and other risk assets as the news of Brexit is digested, we see very, very minimal cause for concern with loans from a fundamental and operational standpoint. We believe any meaningful selloff in the loans that results from the surprising Brexit vote could present an opportunity for long-term investors who are seeking income and diversification to increase their investments in the loan market.
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Mutual funds are subject to market risk and volatility. Shares may gain or lose value.
Fixed income investing entails credit and interest rate risks. Senior loans are typically lower-rated and may be illiquid investments (which may not have a ready market). Diversification does not guarantee profit or protect against loss.