Strong economy drives performance in high yield bonds, leveraged loans

Prices have fallen with the rest of the bond market recently, but the Bloomberg Barclay’s U.S. Corporate high-yield index had a total return of 1.05 percent through Oct. 11. Floating-rate leveraged loans remain the hottest segment of the fixed-income market. The Credit Suisse Leveraged Loan index was up 4.46 percent through Oct. 11. High-yield funds are experiencing outflows this year, but cash continues to pour into leveraged loan funds.

The strength of the U.S. economy is driving performance in both markets.

“The rest of the world is having a hiccup, but the U.S. economy is in great shape,” said Elaine Stokes, a portfolio manager and fixed-income strategist for asset manager Loomis Sayles. She thinks tax cuts and government spending will continue to drive growth in the U.S. economy. “It’s late in the cycle but still too early to get out of high-yield debt.”

Stokes believes that the U.S. economy will remain strong, but not so strong that the Federal Reserve picks up its pace of monetary tightening. She expects a rate hike this month and gives 50/50 odds on another in December. “We’re still on a very slow pace towards higher interest rates,” she said.

The 6.6 percent yield on the high-yield index remains attractive when you consider alternatives. But sharply rising rates don’t help. That’s the main reason the market has shifted dramatically toward leveraged loans. With floating rates pegged to the three-month LIBOR, leveraged loans made to non-investment-grade companies protect against rising interest rates. They also retain seniority in the capital structure over bonds.

More from Fixed Income Strategies:
Your Social Security check will get a 2.8% boost in 2019
40% of American middle class face retirement poverty
Self-driving cars could change the way you move in retirement

“Interest rates are going up, and if you’re in fixed income, there aren’t a lot of good places to go,” said Michael Terwiller, a portfolio manager at investment firm Resource Alts. “I would prefer being in loans with floating rates at the top of the capital structure than in high-yield bonds.”

Doug Peebles, CIO of fixed income at Alliance Bernstein, thinks that bank loans are not what they seem and that investors should be wary. “Loans are the easiest elevator pitch in the markets now,” he said. “They’re senior secured, and they have floating rates.

“I understand why they’re being sold, but senior secured doesn’t mean good credit quality,” Peebles added. “There is deep credit risk involved with these loans.”

Peebles also doesn’t think that leveraged loans live up to their promise of higher income in a rising rate environment. The reason is that loans are callable, and when demand is as strong as it has been for the last year, companies regularly refinance on better terms even as rates are rising. Last year 73 percent of loans were refinanced. That results in lower returns for investors, said Peebles.

Like many others, he also believes the risks of leveraged loans could be much higher this cycle. For one thing, loan covenants — the terms that protect the interests of lenders — have never been weaker. Prior to the financial crisis, approximately 20 percent of loans — i.e., the best credits — were labeled “covenant lite” because of their lesser protections.

Source link

Share with your friends!

Products You May Like

Leave a Reply

Your email address will not be published. Required fields are marked *

Get The Latest Investing Tips
Straight to your inbox

Subscribe to our mailing list and get interesting stuff and updates to your email inbox.