Viewpoints

High Yield and Bank Loans: A Tale of Two Markets

Recent fundamental changes in the leveraged finance markets mean that actively managing credit exposure is more important than ever.

Major fundamental changes in the leveraged finance markets since the financial crisis have resulted in improved credit quality in high yield bonds and greater dispersion in credit quality in bank loans. For investors today, this is a crucial development: In the later stages of the business cycle, it’s more important than ever to distinguish between improving credits and weaker credits that are likely to underperform in an economic downturn.

We think these shifts in the leveraged finance markets underscore the importance of active management in seeking attractive credits with improving prospects and potentially avoiding pitfalls. It is also critical that credit portfolio managers have a thorough understanding of both asset classes since relative value opportunities between the two can be an important source of both alpha and total return.

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The Author

Sabeen Firozali

Credit Strategist

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Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. 

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