Making the case for European senior secured leveraged loans
This high-yielding asset whose coupons increase as interest rates rise should be on more investors’ radars.
Year 2022 will be remembered as an annus horribilis by many traditional fixed income and equity investors. With rising interest rates and inflation chipping away returns, many are now looking to add diversification, efficiency and downside protection to their investment portfolios going into the new year.
The case for European senior secured leveraged loans introduces European senior secured leveraged loans (“European loans”) and discusses why this part of the leveraged finance universe should be firmly on investors’ radar.
These high yield loans offer coupon payments which are linked to a short-term, variable interest rate. They have a low correlation with traditional asset classes and their seniority, security, and covenants mitigate downside risks for investors.
They also offer a higher yield than many traditional fixed income assets. In practise, yields have been above 10% recently, more than 2% ahead of European high yield, and more than 4% ahead of US high yield (hedged to euros).
More importantly, unlike traditional bonds, European loans have a positive exposure to rising interest rates. Their coupons increase when interest rates go up, a much desired characteristic in the current environment.
Although the economic slowdown is likely to continue in Europe next year, current valuations heavily discount future defaults. Based on current yields, it would take unprecedented default rate of 20.4% with recoveries at 50% to wipe out returns. This would exceed the historic peak of 10.5% (2009) by almost 10%.
But despite the European loans market tripling in size over the past decade, the attractive characteristics and the potential value add, these investments still remain absent from many investors’ portfolios. However, the tide is likely to turn in the near future. With European loans well positioned to offer the much needed diversification and downside protection investors are looking for, the market is poised to see its growth continue in 2023.
Our in-depth look at the asset class can be found as a PDF at the top of this page.
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.