While traditional bond portfolios were still attracting a lot of institutional money – more than any other asset class in 2010 – concerns about prices, volatility and duration were prompting more interest in alternatives such as loans. Paul Hatfield, CEO of loans and mezzanine debt specialist Alcentra, said there had been high levels of inquiry in the loans market since last December. “Loans solve the duration issue,” he said, because investors make money whether interest rates rise or fall.

The consensus is that interest rates, in most of Europe and the US at least, can go only one way – up. But, no-one knows when this will happen. Investors were also sick of volatility, he said, and with the sovereign crisis in Europe they were worried about whether bonds were being accurately priced. They were also, however, “yield hungry”, looking for a more constant rate of return. So where did they go? Loans paid a floating rate of interest plus a margin to compensate for credit risk. Bonds, by contrast, were fixedrate instruments with a maturity of seven-to-10 years and were therefore sensitive to changes in interest rates.

The expectation of a higher yield curve was driving investors to seek shorter duration assets. Loans were primarily used to finance leveraged buyouts. They were typically of low duration, secured and had additional covenants for controls over the borrower. Since the financial crisis, the average equity contribution to buyouts had increased, further reducing the risk of the loan component of the deal. In Europe the loan market overtook the high-yield bond market for size in 2005 and is currently about twice its size. Alcentra, an affiliate of BNY Mellon Asset Management, is based in London but has a 25-person US office.

Its main European loan fund aimed to generate returns of between 7.5 per cent and 10 per cent with minimal volatility. Most of the loans were in senior secured debt, with a maximum of 15 per cent in second lien, mezzanine and unsecured bonds and notes. Hatfield said that people often thought that loans were more risky than they actually were. “The recovery rates on loans are higher than they are on corporate bonds because they are closer to the action.

Right now, there is almost no leverage in the system.” Bruce Murphy, the head of BNY Mellon in Australia, said that super funds could see the relative attractiveness in Europe and because loans did not have the same volatility as equities they looked like a good way to take advantage of the opportunities. Hatfield said that most investors put loans in with other absolute-return strategies in terms of their asset allocation, although they did not have many of the disadvantages of other strategies such as high fees and illiquidity

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