Bank Loans: December Lessons
Loan investors learned about illiquidity during December’s volatility, but careful positioning can still add value.
Demand for floating-rate assets waned when market expectations for Fed rate hikes in 2019 fell from two to zero, resulting in record fund outflows. This repositioning caused mutual fund managers and exchange-traded funds (ETFs) to shed their more liquid holdings to cover redemptions, which led to larger loans underperforming smaller, less liquid loans on a price and total return basis. The bank loan market’s limited liquidity, combined with heavy outflows, exacerbated the negative pressure on loan prices, and resulted in performance that appeared to be more driven by liquidity concerns than credit. For example, as the selloff intensified in December, the gap between first- and second-lien discount margins (based on a three-year life) tightened by 34 basis points for the quarter. The painful lesson learned: liquidity is not a given, and the exits tend to shrink on the way out.
Forced Selling from Record Fund Outflows Caused Large Loans to Underperform
Demand for floating-rate assets waned when market expectations for Fed rate hikes in 2019 fell from two to zero, resulting in record fund outflows. This repositioning caused fund managers to shed their more liquid holdings to cover redemptions, which led to larger loans underperforming smaller, less liquid loans on a price and total return basis.
Source: Guggenheim Investments, Credit Suisse. Data as of 1.17.2019. Small loans represent tranche sizes between $200 million and $300 million, large loans represent tranche sizes greater than $1 billion.
While the Credit Suisse Leveraged Loan index lost 3.1 percent in the fourth quarter of 2018, reducing full year returns to 1.1 percent, loans outperformed high-yield corporates for the first time since 2015. Performance across all rating categories was negative, with BBs losing 3.2 percent, Bs losing 2.9 percent, and CCCs losing 4 percent. Despite their underperformance in the fourth quarter, CCCs were the best-performing category in 2018.
Loan Yields Look Competitive to Similarly Rated Corporates
We think bank loans offer comparable value to high-yield corporates. The average BB loan trades at a yield below comparable corporates. This typically occurs toward the end of a hiking cycle.
Source: Guggenheim Investments, Credit Suisse. Data as of 1.24.2019.
In contrast to market expectations, our Macroeconomic and Investment Research Group expects the Fed will raise rates once in 2019, with the hike occurring in the second half of the year. Even without rate hikes, we think bank loans offer comparable value to high-yield corporates. The average BB loan trades at a yield below comparable corporates (see chart, bottom right). This typically occurs toward the end of a hiking cycle. Ultimately, loans should once again outperform other sectors when the Fed recommences its hiking campaign. Given late-cycle dynamics, we continue to defensively position credit portfolios through higher quality, which entails a preference for first lien over second lien loans, with a continued focus on less-cyclical business models with stable cash flows and strong liquidity positions.
—Thomas Hauser, Senior Managing Director; Christopher Keywork, Managing Director
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.
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*Assets under management is as of 12.31.2018 and includes leverage of $12.4bn. Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"), which includes Security Investors, LLC ("SI"), Guggenheim Funds Investment Advisors, LLC, ("GFIA") and Guggenheim Partners Investment Management ("GPIM") the investment advisers to the referenced funds. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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