For almost three decades, bank loans have performed well during periods of market volatility.
Past performance does not guarantee future results.
Despite current market performance, investors appear to be quite optimistic, pulling more money out of money-market funds in the first five months of 2022 than they have in any year in the past decade. So, where is that money going? Year-to-date, large-cap blend, large-cap value, foreign-large blend, long government, and bank-loan funds have seen $171 billion dollars of inflows (approximately 72% of the outflows of money-market funds). Bank-loans remain a top performer for year-to-date returns.
Historically, while correlations for many assets classes have increased, bank loans still offer the lowest correlation to broad investment-grade bonds of major fixed-income sectors. Even more impressive, as of April 30, 2022, bank loans now carry a lower correlation to investment-grade bonds than U.S. large-cap and U.S. small-cap stocks at 0.17 vs. 0.59 for large-caps and 0.51 for small-caps. Meanwhile, as of April 30, 2022, high-yield bonds are near their record 12-month high correlation to broad investment-grade bonds at 0.80 (0.85 is the all-time high).
Historically, when investment-grade corporate bonds, high-yield bonds and bank loans have reached the same price and yield levels as today's, they've generated a 12-month return well above each asset class’s 20-year annualized return (7.20% for high-yield bonds; 4.65% for investment-grade corporate bonds; and 4.65% for bank loans).
Investors searching for yield might do well to consider an investment's risk-adjusted returns, especially with today’s volatility. High-yield bonds and bank loans have historically been two of the top performing asset classes in past Federal Reserve hiking cycles. But even with the 1.29% extra yield offered by high-yield bonds, on a risk-adjusted yield basis, bank loans may offer a more attractive opportunity (4.70% vs.1.34% for high-yield bonds) for those looking to add yield without the volatility that may come with it.
For what has historically been a shelter for investors when volatility has increased, the Bloomberg US Aggregate Bond Index may be facing its worst year return since 1976 and the second year in a row of negative returns. However, bank loans have been one asset class of the fixed-income market that have so far managed to weather the storms of 2022 and generate mostly positive returns for investors year-to-date.
As investors try to balance the major headwinds of rising interest rates and global conflict, finding shelter in short-term, investment-grade fixed income may be a consideration, as yields for front-end fixed income have returned to pre-pandemic levels. While some investors may prefer to seek safe harbor in U.S. Treasuries, short-term, investment-grade corporate bonds might be a better alternative.
Strong demand and a potential favorable environment have been a couple of carryover tailwinds from 2021 for bank loans. Through Feb. 24, the average new-issue loan deal was $959.1 million vs. $781.8 million from the same period in 2021.
Given recent volatility in risk assets, U.S. corporate-debt sectors have seen yields push well past where they started the year. For those investors looking for income, as well as asset classes that have historically done well in past Federal Reserve rate-hiking cycles, corporate debt might be a good option to consider.
The floating-rate nature of the asset class has helped investors during periods of rising interest rates, as the interest rate on loans typically resets every 30-90 days based on the new rate environment and generally move in tandem with the federal funds rate.
Default rates have always been a major factor for investors considering floating-rate loans, which is a primarily non-investment-grade asset class. But with default rates currently tracking well below their historic average of 2.53% (the percentage for January 2022 clocked in at 0.29%), the historical default risk could be significantly reduced in the near term.
Floating-rate loans have historically done well generating returns in rate-hike cycles, which typically have been a difficult period for traditional fixed-income asset classes.
Markets have been volatile so far in 2022. In just one day in January, the Dow Jones Industrial Average fell and gained over 1,000 points. Although a 1,000-plus daily swing sounds overwhelming, the Chicago Board Options Exchange’s Volatility Index (VIX or, informally, the “Fear Index”) has been much higher in the past.
Loan issuance slowed during the last quarter of 2021 to $126.8 billion, but it was more than enough to help 2021 set a record issuance of $615.2 billion. Numerous records were set in 2021 specific to the loan-asset class, including loan and CLO issuance, single-B issuance, and mergers-and-acquisition activity.
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