Loans or Bonds?
Relative value currently favors floating-rate loans over high-yield bondsDownload PDF
The combined effects of strong technicals, fiscal and monetary stimulus, and the search for yield have once again pushed high-yield bond yields below floating-rate loans. While high-yield bonds have historically provided a higher yield than floating-rate loans (due to their lower position in the capital structure and greater downside risk), investors can benefit at times from the risk-adjusted yield dislocation between the two non-investment-grade sectors.
As of June 30, 2021, high-yield bond yields are now 1.08% below floating-rate loans. Over the past ten years, high-yield bonds have averaged a yield of 0.26% above floating-rate loans. Thus, we believe a better relative value opportunity resides in moving up the capital structure and increasing yield by favoring loans over bonds.
On a risk-adjusted yield basis across fixed income, bank loans have offered the highest yield per unit of volatility over the past five years.
Additionally, from a price perspective, high-yield bonds trade at a 5% premium compared to their 10-year average.
As a diversifier relative to major asset classes, bank loans offer better diversification characteristics compared to high-yield bonds.
Navigating this Environment with Pacific Funds
Pacific Funds offers fixed-income funds that are carefully constructed using a combination of investment-grade corporate bonds, high-yield bonds, floating-rate loans, and short-term debt securities. The portfolio management team stays true to its strength as corporate income specialists by researching individual securities and investing across the credit spectrum.
Pacific Funds Floating Rate Income and Pacific Funds Strategic Income have the flexibility to adapt to changing market conditions by adjusting its asset mix to better reflect the investment team’s views on market segments and the interest-rate environment.
Asset-class mix as of June 30, 2021
Bank Loans are represented by Credit Suisse Leveraged Loan Index, which is designed to mirror the investable universe of the U.S. senior secure credit (leveraged loan) market.
Bloomberg Barclays US Aggregate Bond Index includes investment-grade U.S. government and corporate bonds, mortgage pass-through securities, and asset-backed securities.
Duration is often used to measure a bond’s or fund’s sensitivity to interest rates. The longer a fund’s duration, the more sensitive it is to interest-rate risk. The shorter a fund’s duration, the less sensitive it is to interest-rate risk.
Effective yield is the yield of a bond, assuming the periodic interest payments or coupons received are reinvested.
High-Yield Bonds are represented by Bloomberg Barclays US Corporate High-Yield Index, which measures the USD-denominated, high-yield, fixed-rate corporate bond market.
Investment Grade Corporates are represented by Bloomberg Barclays U.S. Credit Index which includes publicly issued U.S. corporate and specified foreign debentures and secured notes.
Mortgage-Backed Securities are represented by Bloomberg Barclays U.S. Mortgage-Backed Securities Index which covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).
U.S. Treasuries are represented by Bloomberg Barclays US Treasury Index which includes public obligations of the U.S. Treasury with a remaining maturity of one year or more.
Yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting.