Senior loans are, in our opinion, an asset class for all seasons. They have historically produced the type of yields that investors seek from fixed-income products, while enjoying unique advantages over other debt investments.
Our view of the senior loan market is fairly simple: There are many great U.S. companies seeking capital and investors can lend it to them at a senior and secured level. That means senior loans occupy a superior place in a company’s capital structure, obligating the company to repay senior loan holders before other debt holders or equity owners.
Addressing Investor Concerns About Senior Loans
Volatility and fears driven by falling commodity prices and slow growth were top-of-mind concerns for senior loan investors from the fourth quarter of 2015 into early 2016, though those concerns have diminished significantly over the last several months.
One of the questions on investors’ minds now is: How will rising interest rates affect the loan market going forward? The floating rate coupons of senior loans are typically tied to the London InterBank Borrowing Rate (LIBOR)1. With rates moving higher, we believe senior loans will continue to be more stable and less volatile than many other fixed-income vehicles because of their floating rate coupons.
As rates rise and investors take inventory of their portfolios, many are discovering they may be heavily weighted toward higher duration2 asset classes. We believe senior loans may provide a nice antidote to that. In the current market environment, senior loans are generating twice the interest investors can get from Treasuries.
Competitive Advantages of Our Senior Loans Approach
Our investment approach to senior loans is driven by bottom-up, fundamental credit analysis. Our analysts get to know companies intimately, and with that knowledge, develop keen insights related to a company’s cash flows, its ability to service its debt, and the underlying trends that may affect its business.
Our relationships with corporate management teams are also important components of our investment process. The size of our fund and our status as a significant lender enables us to develop strong relationships with corporate leaders and, as a result, get information and answers directly from them if questions arise.
Key Differences Between Senior Loans and High-Yield Bonds
In our view, senior loans can be a good fit as a core holding within a long-term investor’s fixed- income portfolio. As a highly uncorrelated3 asset class, senior loans may play a key role in helping increase yield, lower duration, and improve the risk-adjusted returns of an overall investment portfolio over the long term.
Senior loans are often viewed in the same light as high-yield bonds. Both are debt obligations for below-investment-grade companies and both offer the potential for strong relative yields, however, important differences exist.
For example, the senior and secured status senior loans occupy in a corporate capital structure is a key differentiator. High-yield bonds, which are junior in status, typically have been almost two times more volatile of an asset class than senior loans. In addition, loans have little to no duration, while high yield bonds have had historically higher duration as a result of their fixed-rate coupons.
While high yield bonds have their place in an investor’s portfolio, we favor senior loans because they offer the potential for attractive yields while being senior and secured in the capital structure typically offering little to no interest rate risk and lower volatility.
When interest rates were falling in 2016, senior loans performed well. High income, combined with the extra boost of capital appreciation, drove returns. While we don’t expect the same kicker from capital appreciation longer term, we believe investors can still view the asset class as a potential source of attractive income.
With interest rates now on the rise, longer-duration, fixed-income vehicles may not perform as well. In this environment, we believe senior loans will continue to be more stable and less volatile than many other fixed-income vehicles due to their floating rate coupons.
In our view, investors should take a long-term, strategic view of the senior loan asset class.
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- ^The London InterBank Offered Rate (LIBOR) is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks. It is a primary benchmark for short- term interest rates around the world.
- ^Duration measures interest rate sensitivity. The longer the duration, the greater the ex
- ^Correlation expresses the strength of relationship between distribution of returns between two data series. Correlation is always between +1 and –1, with a correlation of +1 expressing a perfect correlation, meaning that the two series being compared behave exactly the same, a correlation of –1 meaning the two series behave exactly opposite and a correlation of zero meaning movements between the two series are random.
OppenheimerFunds is not undertaking to provide impartial investment advice or to provide advice in a fiduciary capacity.
Mutual funds and exchange traded funds are subject to market risk and volatility. Shares may gain or lose value. Senior loans are subject to credit, interest rate and prepayment risk, are typically lower-rated and may be illiquid investments (which may not have a ready market. Fixed income investing entails duration, credit and interest rate risks. Interest rate risk is the risk that rising interest rates or an expectation of rising interest rates in the near future will cause the value of a fund's investments to decline.
Short-term interest rates and longer term treasury rates may or may not move in tandem directionally or in magnitude.
These views represent the opinions the portfolio managers at OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.