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Senior secured credit stands out as yields surge

As inflation rises, senior secured loans offer a relatively undiscovered respite.
Fixed Income

“Today’s entry point is one of the best we have seen for this asset class in its 30-year history,” explained Invesco’s head of investment strategy Ashley O’Connor, referring to the niche US$1.5 trillion ($2.2 trillion) asset class that is senior secured loans. As the name suggests, these are loans to companies that are secured by their assets, and trade in a far more liquid market than many appreciate.

Reflecting at The Inside Network’s recent Income & Defensive Assets Symposium on a career spanning the institutional and wholesale sector, O’Connor said senior secured loans was the asset-class sector he was “most passionate about,” despite having spent time in both areas of the capital stack. A key driver of this is the fact that the asset classes has delivered an income of 6 per cent a year in income to investors over the last 22 years, something that was well-recognised by the industry fund sector amid the depths of the GFC.

While addressing many misconceptions about this massive and growing sector of the market, O’Connor posed the question: “As rates rise, will your portfolio float?”

  • The advantages of senior secured loans are well known; they pay a high and stable monthly income stream (currently 7 per cent) that is floating-rate and reset every quarter, while also being secured across all the assets of the issuer, not just a property or single asset.

    With inflation now a clear and present danger, O’Connor offered evidence of the unique diversification and return opportunity, with senior secured loans having outperformed the broader credit market in each of the nine prior periods when US bond yields had increased by 1 per cent or more. The added benefit is the quarterly resetting of interest payments, which he expects to reach 8 per cent a year within the next six to 12 months.

    How senior secured loans remain undiscovered is a key question, with the US$1.5 trillion asset class split between loans to publicly listed and private companies and making up 16 per cent of all US corporate credit on issue.

    The “asymmetric nature” of lending, which refers to the upside being limited to interest and the downside being default risk, means issuer diversification is paramount.

    The underlying portfolio seeks to invest across 500 issuers with no more than 1 per cent invested into a single issuer, which is key to minimising the impact of default on returns. With defaults on average below 4 per cent, the risk is limited but real, though historically about 60 per cent—70 per cent of capital is returned to senior secured loan investors in the event of complete default. 

    Leaving the audience with an interesting insight, O’Connor highlighted that in 2020, likely the most challenging period for every asset class in several decades, the 5 per cent income from the asset was enough to offset the 2 per cent capital decline for those who chose to hold to maturity.

    Drew Meredith

    Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.




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