Floating Rate Loans: For rising rate environments only?
MOVIN MOKBEL: There’s a misconception that loans are only a feasible investment in a rising rate environment. This view puts too much weight on the floating rate feature that results in higher coupon payments in a rising rate environment, and mostly ignores the more important credit component of loans.
Loans do not need rising rates to perform well. Look at the historical track record. Only two negative years over the past 30 years when we’ve had a number of rate hikes and cuts. Now, if rates stop rising and start to fall, then fixed income will generally do well, including high yield, and loans will follow. Now, that’s assuming markets are not selling off because of a looming recession. Again, you should always just look at the credit component of loans first.
We’re in a market where the average loan price is below 96, so there is still potentially some price upside closer to par, especially because we’re not predicting a recession in 2019.
Take for example our floating rate fund. It has a yield in the range of 8%. It has a Double B minus-rated average credit rating versus B plus for the market, and holds senior-secured first lien loans that sit on top of the capital structure, with primary characteristics of low volatility and high recoveries.
I would like to note that our fund is a flexible mandate. We’re not married to loans or any credit instruments. We must be at least 50% floating rate in the fund at all times. We can accomplish that by switching to investment-grade bonds with a floating rate coupon.
Today, we hold loans because we see value in the asset class, and we can reduce loan exposure as we feel markets are selling off, as we did from the third quarter into the fourth quarter.