Senior Loans: A Fixed-Income Solution for Rising Rates and a Late-Stage Cycle

Why bank loans may offer benefits in today’s economic and market environment

Rates on the rise

As expected, the Federal Reserve’s meeting last month brought another increase in the federal-funds rate—the second hike this year. The meeting also generated new expectations for the remainder of 2018, with the majority of officials now anticipating the Fed will need a total of four rate increases for the year, versus the three estimated in March.

The fixed-income landscape has shifted as the Fed presses on in its rate-hike regime. Bond prices typically fall as rates rise, making many areas of fixed income that benefited from accommodative monetary policy, now look less attractive.

How long can the cycle last?

In addition to the rate environment, the fixed-income landscape changes based on where we are in the credit cycle. While the economy remains strong, it is hard to ignore the fact that we are well into an unusually long economic expansion period. Looking at historical trends, only one expansion period since 1945 lasted longer than the current period—and this one is still in progress. [1]

In the late stages of a cycle, concerns around correlation, credit quality, default risk, and recovery prospects become more pronounced.

Evaluating fixed-income allocations in current market conditions: the case for senior loans

Senior loans, also referred to as bank loans or leveraged loans, offer a number of potential benefits in both a rising-rate environment and later-stage credit cycle. Loans offer higher return potential compared to investment-grade credit, while generally providing lower volatility than high-yield bonds. Loans also offer a number of unique features that are particularly relevant in today’s environment.

In a recent piece, we highlighted three aspects of senior loans that make them a potentially attractive fixed-income allocation given conditions today.

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[1] Source: National Bureau of Economics (NBER). The NBER Business Cycle Dating Committee, which maintains a chronology of the U.S. business cycle, determined that the last expansion began in June 2009. The chronology comprises alternating dates of peaks and troughs in economic activity, which correspond to defined recessions (periods between a peak and a trough) and expansions (periods between a trough and a peak).

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