After 19 straight years of positive returns, the US-centric asset class known as senior bank loans went backwards for the first time in 2008. The universe has recovered swiftly, but promises more action for investors over the mediumterm. Spreads are expected to benefit from big loan demand from private equity managers, who are under pressure to invest billions in capital committed during the boom. The floatingrate nature of the loans will also help them perform well against other forms of fixed income, should central banks eventually start tightening monetary policy. However, the ‘wall of maturities’ out to 2014, comprised of loans struck at the height of cheap money mania in 2006-07, looms as a threat over the loan asset class to some. One of the world’s largest, oldest and most respected managers specialising in senior bank loans, Eaton Vance Investment Managers, sponsored a get-together of Australian asset allocators and fixed-interest managers last month, to debate the role of bank loans in the medium- to longterm.

Scott Page (vice-president, Eaton Vance Investment Managers): When people think of ‘non-investment grade’ in the United States, they think of the high-yield bond market. But there’s another market that’s closely aligned but significantly different from a high-yield bond market, and that’s the leveraged loan market. It’s been around for 20 years, and in the US it was about $600 billion; post-financial crisis that’s shrunk to about $500 billion. In Europe, it’s probably $100 billion to $150 billion. Now, high-yield bonds are subordinated down, they’re unsecured and fixed-rate. The bank loan asset class is senior, secured and floating rate. Those differences make for quite different investment characteristics. Admittedly, the floating rate aspect has not been terribly beneficial, because rates have drifted down for as long as anyone can remember in the US, and everywhere else. But we’re getting excited now about floating rate.

When we look at the instruments available that perform well in a rising rate environment, particularly for people unable to do sophisticated management of fixed or floating, we think bank loans are one of the few fixed-income asset classes with a track record that should perform well in a rising rate environment. The fact that loans are senior and secured has helped to mitigate credit risk. For instance, recoveries [after bankruptcies among our portfolio companies], even through this latest fall cycle of our portfolio, look like they’re going to come in around 70 cents. That lines up with what our recoveries have been for 20 years. So at Eaton Vance we have this unique data set we’re looking at and saying, ‘Well, this is a really cleancut spread.’ We can put it on top of a floating-interest rate. If you were to bring it to Australia, through a simple currency swap, you’d get the Australian short rate plus our credit spread, which is right now on 4 per cent.

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