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Investing for income and defence with senior secured loans
While the uncertain macroeconomic backdrop has kept many investors away from private credit assets, investment management firm Invesco says there are still “compelling” reasons to consider accessing private debt, particularly senior secured loans (SSLs), in the challenging environment.
SSLs offer a high level of current income, Invesco’s private credit team wrote in a recent note. Coupon income for bank loans is around 9 per cent, the highest since 2009. Another draw is SSL’s floating-rate feature, which leaves them with “virtually no duration risk”; they also offer compelling relative value.
“Loans have offered one of the best yields in fixed income while providing downside risk mitigation by being senior in the capital structure and being secured by the assets of the company. Loans have offered these high yields with no duration risk,” Invesco said.
“In a recessionary environment, loans offer downside risk mitigation by being senior, which means they are the highest priority to be repaid in the event of default. Senior secured assets may offer added risk mitigation as we enter a recessionary period.”
Market consensus has central banks at or near peak rates, Invesco said. A pause in interest rate hikes would lower borrowing costs, potentially stimulating demand for new issuance. It would also improve debt serviceability and lead to increased investor demand.
And while retail demand for loans has softened through the broader risk-off sentiment gripping markets, there is still a flow of new collateralised loan obligation creations through 2023, indicating a strong institutional appetite for loans, Invesco wrote. And while technicals are still finding equilibrium, market fundamentals for underlying issuers remain “relatively strong”.
Defaults are low relative to historical levels, and while macro concerns around a potential recession grow, the team believes the risk of defaults will remain low – the in-house forecast is around the 4-4.5 per cent range.
It’s still the largest risk for investors, but they’re being “well compensated on a risk-adjusted basis”, Invesco said.
“We believe there is likely still ample opportunity in the loan asset class to generate higher than historical average returns,” it said. “Following the four periods since the Global Financial Crisis when loan yields exceeded 8 per cent (they are currently around 10 per cent), the loan market has delivered very strong outperformance over the ensuing six to 12 months (with a 10.69 per cent average 12-month forward return).
“We believe this may present a compelling entry point and opportunity for long-term investors.”
