The recent environment for capital markets has certainly been “risk off.” That stems from the unresolved concerns about global trade, uncertainty about the U.S. Federal Reserve’s policy decisions, and a potentially slowing economy.

While none of these factors have directly impacted the fundamentals of our holdings, senior loans–as a credit-centric asset class–have not been immune from the effects of this market sentiment. The impact is evident in the 1.0% decline in the JPMorgan Leveraged Loan Index from October 3 through December 4.

Over this same period, it is worth noting that senior loans did far better than other risk asset classes, given that stocks, as measured by the S&P 500 Index, declined 7.4%, and high-yield bonds, as measured by the JP Morgan Domestic High Yield Index, dropped 2.4%.

All other factors being equal, this outperformance may be attributed to the fact that loans have a senior and secured position in companies’ capital structure.

Importantly, even with the recent risk-off environment, year-to-date (through December 4), senior loans have still had a solid and relatively smooth performance year versus these other classes, generating a total return of 3.5%.

A Positive View on Senior Loans Even Amid Volatility

Our Long-Term Outlook for Loans Is Positive

Even after a volatile month for markets, we remain positive about the long-term outlook for loans for a number of reasons.

  • In all environments, loans warrant consideration as a core fixed income holding because of the multiple benefits they have historically offered.
    Loans provide investors with the potential to earn high income, while providing downside mitigation, as they are secured by their issuers’ assets. Because their coupons frequently reset, they have minimal interest rate risk. Given their relatively low correlation with other asset classes, they also can help provide good diversification for an overall portfolio.
  • In our view, the long-term fundamentals for the loan market remain strong.
    Corporate earnings, from both a top- and bottom-line perspective, have been very solid. Companies’ debt has remained at very manageable levels. Interest coverage ratios are at a 10-year high. In the past 18 months, 75% of loan issuers have either repriced or refinanced their loans. That allows them to strengthen their balance sheets, push out the maturity dates of their loans, and reduce their interest expenses. Default expectations have also remained very low – in the range of 1.5% to 2%. That is well below the historical average of 3% to 3.5%.
  • We think the recent market returns have made loans more attractive on a valuation basis.
    Periods of market dislocation, such as what we are currently witnessing, have traditionally benefitted investors who conduct careful bottom-up research and focus on long-term fundamentals, as these situations create buying opportunities that can help generate long-term outperformance. We believe this to certainly be the case with fundamentals remaining solid, but credit spreads wider by 45 basis points to 425 basis points.

Join us for a conference call on Thursday, December 13 from 3 to 4 p.m. ET. Taylor Watts and Portfolio Managers Joseph Welsh and David Lukkes will discuss the Current State of the Senior Loan Market. Click here to get more details and register for the call.