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Taylor Watts | February 9, 2022

The case for senior loans as we enter 2022

The U.S. Federal Reserve is expected to raise interest rates multiple times this year, which makes now a good time for investors to explore how senior loans may help portfolios in a rising rate environment.

Investors today are faced with two significant challenges in fixed income:

  1. How to protect against interest rate risk
  2. Where to find yield

In this piece, we will discuss how senior loans may offer a strong solution to each of these challenges.

Rising interest rates

When investing in fixed income, investors must consider both credit risk and interest rate risk. Rising interest rates can have just as harmful an impact on fixed income portfolios as credit risk. Investing for income while not losing principal in a rising rate environment can be challenging, but senior loans may help fixed income investors achieve their investment objectives in a wide variety of market conditions. That is especially true in a rising rate environment because of their high relative yields and limited exposure to interest rate risk due to their short duration.

The U.S. Federal Reserve (the Fed) policymakers are widely expected to raise interest rates three to four times this year, starting as early as March. The Invesco Global Senior Loan team believes investors should consider repositioning their fixed income portfolios to better prepare for rising rates. Structurally, senior loans pay interest based on floating rates, so loans have significantly much less duration (or interest rate risk) than many fixed income categories.

Senior loans have performed well during periods of rising rates

Index returns when the 10 year U.S. Treasury increased more than 100bps

Source: Senior Loans represented by the the Credit Suisse Leveraged Loan Index (CS LLI) (outsized return in 2008-2009 period was 44%, edited for scale), IG Corporates represented by the Bloomberg U.S. Corporate Bond Index, U.S. Aggregate represented by the Bloomberg U.S. Aggregate Bond index, 10 Year Treasury represented by the FTSE 10-Year Treasury Benchmark Index.
Past performance is not a guarantee of future results. An investment cannot be made into an index.

High income potential

Even if the widely expected Fed rate hikes are surprisingly fewer or postponed, we believe the high levels of income typically produced by senior loans should keep them competitive in terms of total return prospects for 2022, relative to other fixed income categories.

The senior loan market, like any other capital market, is subject to a certain amount of price volatility based on investor sentiment, technical factors of supply and demand, and/or valuations. Yet, because senior loans sit atop a company’s capital structure and are secured by the company’s assets, they can be an effective tool for delivering income generation and capital preservation objectives. We believe senior loans should be a core allocation in all fixed income portfolios and, for the reasons cited above, we believe senior loans may be an especially appealing option for 2022.

U.S. senior secured loans offer one of the best yields in fixed income

Source: Barclays, JP Morgan, Credit Suisse, and Bloomberg L.P. as of December 31, 2021. Bloomberg U.S. Corporate Bond index represents IG corporates, the JPM U.S. HY index represents High Yield and Credit Suisse Leveraged Loan Index (CS LLI) represents the Leveraged Loans. Loan Yields represented yield to 3 year.
Past performance is not a guarantee of future results. An investment cannot be made into an index.

Summary

Senior loans may deliver several compelling characteristics that can make them an attractive long-term core holding in fixed income portfolios in various environments. In today’s market environment, two of those characteristics are particularly relevant:

  • Senior loans can help protect against interest rate risk as they have extremely short duration of approximately 0.25 years on average.
  • Senior loans generally deliver relatively high levels of income/yield compared to other fixed income asset classes.

Invesco Canada offers exposure to senior loans through the Invesco Floating Rate Income Fund.

More from Taylor Watts

The case for senior loans as we enter 2022
February 9, 2022

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Important information

NA2027669

Header image: Yevgenia Gorbulsky / Adobe Stock

Some references are U.S. centric and may not apply to Canada.

Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or from Invesco Canada Ltd.

There is a risk that the value of the collateral required on investments in senior secured floating rate loans and debt securities may not be sufficient to cover the amount owed, may be found invalid, may be used to pay other outstanding obligations of the borrower or may be difficult to liquidate.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

All investing involves risk, including the risk of loss.
The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market.
The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the intermediate-term investment grade, U.S. dollar-denominated, fixed-rate taxable bond market.
The Barclays U.S. Investment Grade Credit Index measures the investment grade, U.S. dollar-denominated, fixed-rate, taxable corporate and government-related bond markets.
The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar - denominated leveraged loan markets

The JPMorgan U.S. High Yield Index is an unmanaged index that tracks the performance of U.S. dollar denominated, below investment-grade rated corporate debt publicly issued in the U.S. domestic market.

The FTSE 10-Year Treasury Benchmark Index measures total returns for the 10-year U.S. Treasuries that settle by the end of the calendar month.

The opinions referenced above are those of the author as of Jan. 25, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.