Senior loans in a multi-asset portfolio?

Might senior loans play a role in a multi-asset portfolio?

They can with specific objectives and the right multi-asset expert.

One key potential benefit of multi-asset investing is the often closely managed exposure to specific factors. And one factor we believe in is senior loans, also known as bank loans or leveraged loans. If the right asset management skills are in place, we believe bank loan exposure can help to deliver desired investment outcomes.

How are bank loans different?

Let’s start with the asset class. Bank loans are corporate debts that are issued by below-investment-grade companies. Bank loans typically have a high correlation to high-yield bonds, which are also issued by companies with below-investment-grade credit ratings, such as BB- or B-rated issuers.1

How might bank loan exposure benefit a portfolio?

  • They may often offer relatively high income to compensate greater credit risk, when compared to other, more typical investment grade fixed income exposures, like the yield to maturity of 6.7% for Credit Suisse Leveraged Loan Index, compared to 2.5% yield to maturity for Bloomberg  U.S. Aggregate Index as of April 30, 2017.
  • Bank loans may have minimal interest rate risk associated with them because their coupons are tied to LIBOR (London Interbank Offered Rate), a benchmark rate that some of the world’s leading banks charge each other for short-term loans. So, the interest income associated with bank loans float as interest rates rise, meaning higher interest rates can result in higher interest income for bank loan investors.
  • They sit in a senior position to the capital structure of a company, meaning they have the first claim to the company’s assets if the company goes to default, so they get more recovery. In other words, bank loans might help to provide better downside protection from credit risk than high-yield bonds, all else being equal.
  • Bank loans can help to offer diversification benefits because historically they often don’t have as much interest rate risk as other fixed income instruments, and less volatility than high-yield bonds. For instance, bank loans had -0.0 correlation to the Barclay’s U.S. Aggregate Index and 0.59 correlation to the S&P 500® Index for the last 10 years as of March 31, 2017. High-yield bonds had 0.74 correlation to the S&P 500 Index for the same period. Keep in mind that a 1.0 correlation would indicate perfect alignment with the index.

Skills that may be needed to help bank loans work in a multi-asset portfolio

Our investment strategists believe bank loans can help to provide high value in a diversified multi-asset portfolio, but also require skilled managers to deliver on the potential benefits stated above.

Finding managers with such skills can be a daunting task for many kinds of investors. We believe that an investment expert for this kind of task, demands a commitment to deep active manager research. We also believe exposure to senior loans requires thoughtful asset allocation and is likely to work best when an asset manager can dynamically manage portfolio allocations and adjust as needed to meet an investors’ desired outcomes.

Could bank loans be part of a multi-asset portfolio? We believe the answer can be yes, with one big caveat: it is important to ensure that any asset manager?–or professional investment advisor?–an investor chooses to work with be an expert who has the required skills to provide such market factor choices within a multi-asset portfolio, remembering that all investments have risk.

1 Credit ratings provide a useful measure for comparing fixed-income securities, such as bonds, bills and notes. Investment grade refers to the quality of a company's credit. In order to be considered an investment grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's. Anything below this 'BBB' rating is considered non-investment grade. If the company or debt is rated 'BB' or lower it is known as junk grade, in which case the probability that the company will repay its issued debt is deemed to be speculative.