High-Yield Bank Loans: Look Before You Leap

High-yield bank loans are a hot topic again in capital markets, with features touted as ideal for today’s environment. But we think it makes sense to take a closer look at what bank loans really are—and aren’t. In our opinion, there are a few holes in the case for piling into high-yield loans.

High-yield loans have been in the spotlight before. They were popular in 2010, too, and the rationale was similar to today’s. Bank loans pay floating coupon rates, so they’re expected to beat bonds if interest rates rise. Since loans are higher than bonds in the capital-structure pecking order, investors should be able to recover more of their investment in the event of a default. And bank loans offer relatively attractive yields at a time when yield is a commodity.

Many investors are ready to jump in with both feet. Our advice: take a good look before you do.

High-yield loans didn’t keep pace with high-yield bonds back then. In fact, loans have trailed bonds over the past seven years by almost 30% cumulatively. As the display below shows, that works out to an average outperformance of 0.3% a month: 0.7% versus 0.4%. Loans also trailed in tough credit markets such as the one in 2008—despite being higher in the capital structure.High-Yield Bonds Have Outperformed Loans Whether Rates Rise or Fall In falling rate environments, loans have underperformed bonds dramatically—by about half a percent per month when Treasury bonds have posted positive returns. Of course, to be fair, the concern today is more about rising rates. But even in months when interest rates have risen, high-yield loan returns have still trailed high-yield bond returns.

That’s because rising rates are often accompanied by improving credit conditions, which can make it more advantageous for a company to refinance its loan. High-yield loans can be refinanced at any time (more on that in an upcoming post), and borrowers refinance when it benefits them, not investors. Management hands investors their money back and moves on.

High-yield bonds still feel some impact from rising rates, don’t they? They do, but historically much less than you might think.

It’s not so much interest-rate sensitivity, or duration, that’s had the biggest effect on high-yield bonds. Changing credit conditions have been a much bigger influence. That’s why we think the concern about rising rates has been overstated.

Still, some investors might feel more comfortable with bonds that are even more resilient against rising rates. One solution might be short-duration high-yield bonds—specifically, those with higher credit ratings of B and BB. Over time, these bonds have delivered stronger returns than loans (see display below). In fact, they’ve nearly matched the broader high-yield bond market. And they’ve done it with a lot less risk.Are High-Yield Loans as Good as They Sound? We’re not saying there’s no place for high-yield loans in a diversified portfolio. However, in our view, jumping in too deep would be a mistake. That’s especially true if it means jumping out of high-yield investments that our research indicates could be more effective.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Ashish Shah

Head—Global Credit
Ashish Shah is Head of Global Credit and a Partner at AllianceBernstein. He is also a member of the Absolute Return portfolio-management team. Prior to joining the firm in 2010, Shah was a managing director and head of Global Credit Strategy at Barclays Capital, where he was responsible for the High Grade, High Yield, Structured Credit and Municipal Strategy Groups, and the Special Situations Research team. Prior to that, he served as the head of Credit Strategy at Lehman Brothers, leading the Structured Credit/CDO and Credit Strategy Groups and covering the cash bond, credit derivatives and CDO product areas for global credit investors. Before that, Shah served as North American CFO at Level 3 Communications from 1999 to 2000 and gained trading experience at Soros submanager Blue Border Partners and at Bankers Trust, where he ran US equity arbitrage from 1994 to 1999. He holds a BS in economics from the Wharton School at the University of Pennsylvania. Shah has long been committed to diversity issues and has led several key diversity-related initiatives across the firm. Location: New York

Gershon M. Distenfeld, CFA

Director—High Yield
Gershon M. Distenfeld is Senior Vice President and Director of High Yield, responsible for all of AllianceBernstein’s US High Yield, European High Yield, Low Volatility High Yield, Flexible Credit and Leveraged Loans strategies. He also serves on the Global Credit, Canadian and Absolute Return fixed-income portfolio-management teams, and is a senior member of the Credit Research Review Committee. Additionally, Distenfeld co-manages the High Income Fund and two of the firm’s Luxembourg-domiciled funds designed for non-US investors, the Global High Yield and American Income Portfolios. He has authored a number of published papers and initiated many blog posts, including “High Yield Won’t Bubble Over,” one of the firm’s most-read blogs. Distenfeld joined the firm in 1998 as a fixed-income business analyst. He served as a high-yield trader from 1999 to 2002 and as a high-yield portfolio manager from 2002 until 2006, when he was named to his current role. Distenfeld began his career as an operations analyst supporting Emerging Markets Debt at Lehman Brothers. He holds a BS in finance from the Sy Syms School of Business at Yeshiva University and is a CFA charterholder. Location: New York

Ivan Rudolph-Shabinsky, CFA

Portfolio Manager—Credit
Ivan Rudolph-Shabinsky is a Portfolio Manager on the Credit team and leads the Low Volatility High Yield Portfolio Management team. He joined the firm in 1992 as a Portfolio Manager, and has held several posts, including head of the Product Development team; head of Product Management; and senior portfolio manager for the Stable Value, Inflation-Linked Bond, Canadian Fixed Income and Global Fixed Income teams. Rudolph-Shabinsky is the author of “Beyond Interest Rate Anticipation: Strategies for Adding Value in Fixed Income” and co-author of “Assigning a Duration to Inflation-Protected Bonds,” both published in Financial Analysts Journal. He also co-wrote both “Managed Synthetics,” published in The Handbook of Stable Value Investments, and “LDI: Reducing Downside Risk with Global Bonds,” published in The Journal of Investing. Rudolph-Shabinsky holds a BA in economics and Soviet/East European studies from Cornell University and an MBA from Columbia University. He is a CFA charterholder. Location: New York

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