Senior secured loans can thrive in a low yield environment

Senior secured loans have a strategic purpose in investors’ portfolios and the search for yield has caused an increasing number to zoom in on the asset class. The selection of a loans manager is however not without pitfalls.

Senior secured loans – also known as bank loans, leveraged loans or syndicated loans – have caught investors’ interest and rightfully so. Compared to some other alternatives in a low yield environment, senior secured loans have some very attractive features. US investors have long been accustomed to the asset class, but it is only within the last couple of years the interest has gained momentum in Europe. 

The main reasons for intensified interest have been the hunt for yield combined with fear of rising interest rates. Senior secured loans present a good solution for that equation because they have a floating rate and offer a yield, on a default loss adjusted basis, equivalent to high yield but senior in the capital structure.

Investors recognise these attractive characteristics but many lost interest once they realised the complexity of loans regarding settlements, liquidity and operational complexity compared to traditional high yield bonds. A part of the challenge in Europe is that loans are not broadly Ucits eligible.

Before applying the same search methodology that investors use for traditional fixed income asset classes such as US high yield, it is imperative that investors familiarise themselves with specific characteristics of senior secured loans. Investors should, of course, always understand key drivers of performance within an asset class. The difference with loans is that the drivers and pitfalls are not that obvious. 

One drawback is that managers’ track records are not necessarily comparable. Some managers focus mainly on CLOs (collaterised loan obligations) while others have focused on managing separate accounts. 

This creates natural performance differences since CLOs are generally more restrained regarding credit rating allocation, sector allocation and diversification. The fact that some managers have mainly managed closed-end funds with leverage has complicated the quantitative screening. Even if you de-lever the numbers, there is some trace of leverage or beta in the track record.

The size of the issues the manager focuses on also varies greatly. If you do not factor this in you will end up comparing large cap with small cap managers. Within equities, you would never do that but this issue is not really recognised in fixed income area. The special caveat is that you get an illiquidity premium with small cap managers and simultaneously have lower volatility, because these loans are less traded. However, the volatility spike in case of market turmoil for small cap managers can be an unpleasant surprise. 

Another very important aspect is the size of the strategy the manager is running. Some of the biggest US senior secured loans managers manage more than $20bn (€18bn) in a $900bn market. Investors need to recognise the benefits and disadvantages of size. Managers with sizable assets get typically better absolute allocations from syndicates. On the other hand, smaller managers can be more selective in their investments and more active in the secondary market.

During our search for a US senior secured loans manager, we came across a large variety of managers. The managers typically have different pedigrees – from traditional fixed income managers who have ventured from high yield into loans, to credit boutiques that focus on specialised credits including loans. 

We valued credit boutiques in our search for US loans and selected Oak Hill Advisors. They have the most compelling offering and a large and very experienced investment team led by the charismatic Alan Schrager. 

Their investment organisation is built on managing loans and other specialised credit and the track record proves their case. When it comes to size, they are in a sweet spot with $7bn in assets under management. This means they are big enough to be important for brokers and syndicates but also small enough to be selective in the primary market and active in the secondary market.     

Anders Bertramsen, head of fixed income, External Products, Nordea Wealth Management