In falling rate environments, loans have underperformed bonds dramatically—by about half a percent per month when Treasury bonds have posted positive returns. Of course, to be fair, the concern today is more about rising rates. But even in months when interest rates have risen, high-yield loan returns have still trailed high-yield bond returns.
-Ashish Shah, co-head of global credit investments, AllianceBernstein
High-yield bank loans are a hot topic again in capital markets, with features touted as ideal for today’s environment. But we think it makes sense to take a closer look at what bank loans really are—and aren’t. In our opinion, there are a few holes in the case for piling into high-yield loans.
High-yield loans have been in the spotlight before. They were popular in 2010, too, and the rationale was similar to today’s. Bank loans pay floating coupon rates, so they’re expected to beat bonds if interest rates rise. Since loans are higher than bonds in the capital-structure pecking order, investors should be able to recover more of their investment in the event of a default. And bank loans offer relatively attractive yields at a time when yield is a commodity.
Many investors are ready to jump in with both feet. Our advice: take a good look before you do.
High-yield loans didn’t keep pace with high-yield bonds back then. In fact, loans have trailed bonds over the past seven years by almost 30% cumulatively. As the display below shows, that works out to an average outperformance of 0.3% a month: 0.7% versus 0.4%. Loans also trailed in tough credit markets such as the one in 2008—despite being higher in the capital structure.
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