What to Make of Senior Loans? Key Points as Yields Rise

The fall so far has seen a marked increase in yields, following the Fed’s rate hike last month. Both the 30-year and 10-year Treasurys have reached multi-decade highs, as governments compete with tech issuers for credit and geopolitical risk remains high. That landscape makes understanding the wide crop of debt securities even more critical for investors and advisors. In senior loans, for example, opportunities and risks are shifting in response.

Key Takeaways:

• The rapidly shifting yield enviornment offers opportunity and uncertainty in spades, but senior loans can appeal.
• The category combines floating rates and high yields, while taking priority for repayment if borrowers go bankrupt.
• Senior loan ETFs combine the ETF wrappers' tax efficiency and transparency with the category's potential yields.

As a refresher, senior loans are riskier than government and investment-grade bonds, on the whole, but safer than explicitly high yield offerings. That places them in an intriguing slot for many investors’ fixed income portfolios.

Such loans combine capital protection, requiring priority repayment in case borrowers go bankrupt, with stronger yields than investment-grade bonds. They also mostly come with floating rates.

As yields rise, then, what role do those loans have in that middle ground? According to recent analysis from Voya Managing Director, Head of Bank Loans and Global CLOs Mohamed Basma, the last week saw some notable points.

A combination of net negative supply, steady retail fund inflows, and strong CLO creation all lay a solid foundation for senior loans to continue to perform. At the same time, senior loans provide some protection from rising rates as well as high coupon income that offsets falling secondary market prices. Finally, borrowers still appear to have the durability to handle economic uncertainty and rising borrowing costs.