With rising rates and volatile global economic news, Loomis Sayles’ Bank Loan team compares the asset class to other investments, both fixed income and otherwise, and discusses how these unique investments fare through the credit cycle.
Among fixed income assets, bank loans have several key advantages including seniority, security, and a floating interest rate. Furthermore, bank loans can offer unique characteristics relative to higher and lower yielding fixed income asset classes. As pictured below, their investment profile generally places bank loans between high yield bonds and investment grade bonds (including Treasurys).
Comparison of Fixed Income Asset Classes
Source: Standard & Poor’s Leveraged Commentary and Data and BofA Merrill Lynch. Data as of 31 December 2021. Please note that the BofA Merrill Lynch US Corporate Index reflects the performance and characteristics of the investment grade corporate credit asset class.
The long-term strategic case for bank loans is driven by the asset class’s behavior over a full credit cycle. The credit cycle is characterized by market conditions of rising rates or declining corporate credit conditions. While rates tend to rise in an improving economy, corporate credit conditions tend to decline in a deteriorating economy.
When investors’ risk appetite is strong, higher-risk assets may outperform bank loans. Conversely, when investors are risk averse, higher-quality assets can outperform loans. Given relative market swings, when allocating around bank loans, the ability to add risk through high yield or reduce risk via Treasurys (for example) can help an active portfolio manager benefit from different phases of the business cycle, as well as technical pressures.
Potential Allocations Through the Business Cycle
Source: Loomis Sayles. The graphic reflects the opinions and assumptions of the authors only and does not necessarily reflect the views of Loomis, Sayles & Company, L.P. Others may have different views. These views apply under normal market conditions and are subject to change at any time without notice.
The relatively low correlation of bank loans to other asset classes could provide diversification for fixed income portfolios. Furthermore, low volatility from interest rate changes and credit pressures suggests that bank loans should have low long-term correlation with other investment categories. As pictured below, only high yield has exhibited a strong correlation to bank loans' returns, a phenomenon significantly increased by the global financial crisis.
Diversifying Portfolios with Bank Loans
January 1992 – December 2021
Source: Credit Suisse, Bloomberg Inc. and Ibbotson Associates. Data as of 31 December 2021.
- Bank loans’ greater yield potential versus investment grade assets reflects the greater perceived risk of the asset class, while the slightly lower yield relative to high yield is the result of bank loans’ higher position in the capital structure.
- For investment grade investors seeking more yield, bank loans provide an intermediate step up on credit risk.
- Over the credit cycle, because economies tend to rise or fall more than they stay the same, one of the two tactical drivers for bank loans is often in effect. Most other asset class categories are generally hurt by rising rates, declining corporate credit, or both.
- The strategic case for holding a long-term bank loan allocation is due to the asset class’s unique characteristics that adjacent sectors – high yield bonds or investment grade corporates – generally lack.
Bank Loans: Looking Beyond Interest Rate Expectations
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Diversify with Bank Loans
While bank loans are an important tool during rising interest rates, they may also offer wider long-term advantages as a diversifier in fixed income or broader portfolios.
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This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
Floating rate loans are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate loans is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate loans can be relatively illiquid and hard to value.
Credit risk is the risk that the issuer of a fixed income security may fail to make timely payments of interest or principal or to otherwise honor its obligations.
Liquidity risk exists when particular investments are difficult to purchase or sell, possibly preventing the sale of these illiquid securities at an advantageous price or time. A lack of liquidity also may cause the value of investments to decline.
Diversification does not guarantee a profit or protect against a loss.
Before investing, consider the fund's investment objectives, risks, charges, and expenses. Visit im.natixis.com or call 800-225-5478 for a prospectus or a summary prospectus containing this and other information. Read it carefully.