Don’t Bank on Bank Loans
Bank loans are an easy sale today. If you’re worried about rising rates, you want to be in floating-rate debt. Also, they have the advantage of being higher in the capital structure. That’s the very simplistic view of looking at bank loans. But when you dig a little deeper, we see that all is not what it seems.
There’s a lot of things that you’re told about loans that are, technically speaking, correct, but when you dig a little bit under the surface you realize that the reality for most investors is very different.
Let’s start with analyzing: are you really senior in the capital structure? Technically yes, but investors need to know that two out of every three loan issuers don’t have any debt underneath them. So they are senior, but they’re not senior to anything. Which means that recoveries are not going to be as high as they were in the past, in event of default.
Look at the floating-rate aspect. Are they technically floating rate? Yes, they are. However, they don’t behave like floating-rate notes. Because there’s a little clause in every contract between the investor and the issuer. And that is that the issuer—the company—can call the loan at any time, for any reason, usually with no prepayment penalty.
That means that when people throw more money into the loan market, what ends up happening is companies then are able to call the existing loans, reissue them at lower spreads and lower yields. So at the end of the day, as an investor, you’re not making the return you thought you were. The bank loan market is the only market I can think of where the more money that gets put into it, the lower investors’ returns are.
What’s the lesson? Will there be times where loans hold up better than high yield? Absolutely. Second quarter of 2013, loans did slightly better. But unless you can pick out those very short periods of time where loans do better, you’re much better off just sticking with high yield.
We at AB know that many clients are concerned about rising rates, and there could be some short-term impacts. But what most fixed-income investors should realize is that rising rates are actually good in the long run.
Yes, the price might go down in the short term, but then all the bonds that come due in a portfolio, and in a high-yield portfolio that could be significant; about 20% of bonds mature or get called every year. When those bonds get reinvested, they get reinvested at higher yields. And eventually that leads to more income for investors and higher total returns.
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The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
Gershon M. Distenfeld thrives on facing challenge, solving problems and putting people with different personalities and different viewpoints together to "make the engine run." When he joined AB in 1998 from a role as an operations analyst at Lehman Brothers, Distenfeld had long been fascinated by the high-yield market, and he led that practice at AB from 2006 to 2016 before assuming responsibility for all of credit. He has been co-head of fixed income since 2018.
In an industry that tends to focus on the short term, Distenfeld's investment philosophy takes the long view, considers a range of outcomes and focuses on the downside. This approach puts process and constant innovation at the forefront, making full use of AB's proprietary technology to mine the insights of fundamental and quantitative research.
"We're constantly reinventing ourselves," Distenfeld says. "We don't just sit still. We adapt to new information so we can find new factors that work."
Distenfeld's eye toward the long view extends to his charitable work with organizations like New Jersey NCSY. This youth organization for disaster relief partners with Habitat for Humanity and NECHAMA to repair homes and lives affected by natural disasters.
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