On March 16, 2017
Senior Loan February 2017 Review and Outlook
An improving global economic backdrop, relatively high expectations of growth-friendly government initiatives and generally positive year-end earnings reports helped support U.S. and global stocks to add to their post-U.S. election gains in February. Bond yields in the United States declined modestly after rising sharply in November and December with the 10-year Treasury note slipping to 2.36%, even as the Federal Reserve appeared to be on track to raise interest rates several times later this year. Most sovereign yields in Europe trended lower amid heightened political uncertainty surrounding upcoming elections in France and the Netherlands.
In this environment, the senior loan sector experienced its eighth consecutive monthly gain as measured by the JPMorgan Leveraged Loan Index. Senior loan funds (1.7% return on market price) within the closed-end-fund universe outperformed the JPMorgan Leveraged Loan Index, benefiting from modest narrowing of the average discount to the funds’ underlying assets, as well as the use of leverage. Senior loan closed-end funds also fared better than longer-dated U.S. Treasuries, investment-grade corporate bonds and high-yield bonds, but worse than preferred securities.
Demand for senior loans remained strong. Open-end mutual funds that invest in senior loans have reported net inflows in 30 of the last 31 weeks, averaging $1 billion of inflows each week since the U.S. election. This suggests that senior loan funds’ historically low sensitivity to interest rates continues to resonate with investors who anticipate an upward trend in interest rates.
After years of disappointing growth, we expect the global economy to accelerate in 2017, led by strength in the United States, followed by Europe and Japan also seeing improvement. The promise of tax reforms and increased fiscal spending under the Trump administration has lifted expectations for higher asset prices and yields in the United States, but other policies have raised questions around global trade and geopolitical strategy. On balance, we expect the impact of new policies to add to the growth and inflation trends that were already underway.
Policymakers are likely to continue to react to growing inflation, and we expect the Federal Reserve to raise rates again in the near term. Generally, we see fixed income assets continuing to be more vulnerable to rising yields over time, but believe senior loans remain well positioned relative to other areas of fixed income.
Senior loans have characteristics that have historically helped them outperform other fixed income classes during periods of rising interest rates. Their floating interest-rate structure limits duration risk, as rates reset frequently — often every 40 to 60 days. Senior loans also offer the potential for attractive income rates with high levels of diversification due to their low historical correlations to other fixed income sectors, potentially acting as a cushion against rising rates.
Ultimately, we believe investment opportunities in senior loan closed-end funds may be largely dependent on economic and employment data, as well as changes in expectations to central bank interest rates — particularly at the Federal Reserve.
Risks of Investing in Closed-End Funds. Shares of many closed-end funds frequently trade at a discount from their net asset value. The funds are subject to stock market risk, which is the risk that stock prices overall will decline over short or long periods, adversely affecting the value of an investment in a fund.
The J.P. Morgan Leveraged Loan Index is designed to mirror the investable universe of U.S. dollar institutional leveraged loans, including U.S. and international borrowers. The J.P. Morgan U.S. Liquid Index is a market-weighted index that measures the performance of the most liquid issues in the investment grade, dollar-denominated corporate bond market.
Senior Loans Risk: The risks associated with senior loans are similar to the risks of junk bonds, although senior loans are typically senior and secured, whereas junk bonds are often subordinated and unsecured. Investments in senior loans are typically below investment grade and are considered speculative because of the credit risk of their issuers. Such companies are more likely to default on their payments of interest and principal owed, and such defaults could reduce a Portfolio Fund’s net asset value and income distributions. An economic downturn generally leads to a higher non-payment rate, and a senior loan may lose significant value before a default occurs. There is no assurance that the liquidation of the collateral would satisfy the claims of the borrower’s obligations in the event of the nonpayment of scheduled interest or principal, or that the collateral could be readily liquidated. Economic and other events (whether real or perceived) can reduce the demand for certain senior loans or senior loans generally, which may reduce market prices. Senior loans and other debt securities are also subject to the risk of price declines and to increases in prevailing interest rates, although floating-rate debt instruments such as senior loans in which certain Portfolio Funds may be expected to invest are substantially less exposed to this risk than fixed-rate debt instruments.
Opinions in this piece are those of Cohen & Steers and are not necessarily that of AAM.
The views and opinions in the preceding commentary are as of the date of publication and are subject to change. There is no guarantee that any market forecast set forth in this presentation will be realized. The preceding commentary does not reflect the performance of any fund or account managed or serviced by Cohen & Steers and there is no guarantee that investors will experience the type of performance reflected in this commentary. This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material represents an assessment of the market environment at a speciﬁc point in time, should not be relied upon as investment advice, is not intended to predict or depict performance of any investment and does not constitute a recommendation or an offer for a particular security. We consider the information in this presentation to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of suitability for investment.
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