Global markets ended 2018 on a sour note with US equities returning -9.03% in December, their worst monthly performance since the Global Financial Crisis.1 Negative market sentiment was driven by concerns over slowing global growth amid tightening US monetary policy and further trade tension with China. The Federal Reserve (Fed) delivered a "dovish hike" during the month by simultaneously raising rates by another 25 basis points and reducing its guidance for 2019 rate increases; however, the Fed's inclination to further increase rates was poorly received by nervous investors. Amid the turmoil, senior secured loans were impacted by investors' risk aversion and the resulting selling pressure. Outflows during the month were driven by retail and institutional accounts rotating into cash amid weaker overall market sentiment and lower future rate expectations. On a relative basis, loans significantly outperformed equities, and were nearly in line with high yield returns in December. Away from the technical weakness, credit fundamentals in the loan market remain supportive of low defaults in 2019 given issuers' strong earnings growth and manageable interest coverage ratios. Overall, loans returned -2.54% for the month, bringing 2018 returns to 0.44%,2 which meaningfully outpaced fixed rate credit during the year.
Loan market technicals were pressured in December by heavy withdrawals from the asset class, including $9.9 billion of retail outflows.3 CLO issuance also slowed markedly amid declining loan prices and widening liability spreads. New CLO issuance is still expected to remain strong in 2019, however the pace of CLO creation will likely remain muted until the market stabilizes. Meanwhile, new loan supply slowed to a trickle in December as widening primary and secondary loan spreads discouraged opportunistic transactions from coming to market.
As loan spreads continued to widen, the percentage of loans trading above par declined to under 1% during December. Notwithstanding this price weakness, loans outperformed high yield during the volatile fourth quarter. Over that period, loan returns of -3.45% outpaced high yield returns of -4.63%.4 The largest 100 loans - which tend to be the most liquid - collectively underperformed the broader loan market by 62 basis points in December,5 highlighting the technical nature of the selloff. Overall, "CCCs" (-3.34%) succumbed to the prevailing risk aversion, underperforming higher quality deals. "BBs" (-2.56%) actually underperformed "Bs" (-2.52%) due to the aforementioned technical selling pressure in larger, liquid loans.5 The average price in the loan market was $94.16 at the end of December.5 At the current average price, senior secured loans are providing a 8.44% yield inclusive of the forward LIBOR curve.6
Despite sustained price declines during the fourth quarter, loans have bested high yield since the onset of market volatility at the beginning of October. This added to material year-to-date outperformance of loans versus high yield of +2.70%, while maintaining loans' outperformance versus investment grade of +2.69%.4 As in past episodes of elevated market volatility, weakness in high yield eventually does impact demand for loans as changing spread differentials alters the relative value consideration for crossover investors, and as high yield funds tend to liquidate loan holdings to raise cash for redemptions. However, this weaker market technical is misaligned with the stable credit fundamentals underpinning loan issuers, and has caused many performing credits to trade moderately below par.
Adding to the selling dynamic in recent months has been retail investors' belief that loans have become less attractive as expectations for future rate increases have diminished. While coupon accretion stemming from base rate increases is likely to slow relative to 2018, loans continue to offer a compelling high return / lower volatility opportunity for investors harboring concern about the maturation of the US economic growth cycle. As illustrated throughout a volatile 2018 for risk assets, loans' senior secured status helped stabilize the asset class in the face of higher market volatility, enabling loans to decouple from broader credit markets to a degree. The defensive positioning within issuers' capital structures has served investors well historically from a risk adjusted return perspective and should continue to insulate the asset class from volatility that may arise in 2019. To the extent that technical weakness dissipates and the loan markets' solid fundamentals come back into focus in 2019, recent price weakness could develop into a significant opportunity for long-term minded loan buyers. A truncated pipeline of expected defaults in the year ahead indicates that recent loan market indigestion has created a degree of mispricing not seen since early 2016, a year that ultimately delivered above average loan market returns.
Loans have significantly outperformed during 2018 – total returns
Source: Bloomberg L.P. as of Dec. 31, 2018. US Senior Loans represented by S&P/LSTA Leveraged Loan Index; US HY Bonds represented by BAML US High Yield Index; Investment Grade Bonds represented by the BAML Investment Grade Index. Equities represented by S&P 500 Index. Returns shown are total returns in USD. Past performance is not a guide to future returns. An investment cannot be made directly in an index.
Loans offered investors a high level of current income with short duration
Source: Bloomberg L.P., Barclays, JP Morgan, and S&P LCD as of Dec. 31, 2018. Past performance is not a guarantee of future results. An investment cannot be made directly in an index.
Yield to worst (%)
Spread to worst
At forward Libor
5 Year Treasuries
10 Year Treasuries
Bloomberg Barclays US Agg Index
T + 0.66
Bloomberg Barclays IG Index
T + 1.43
JPM US HY Bond Index
T + 5.67
S&P/LSTA Leveraged Loan Index5
L + 5.51
T + 5.98
Source: S&P LCD, Barclays, JP Morgan and Bloomberg L.P. as of Dec. 31, 2018. Loan "spread to worst" and "at forward Libor" incorporate LIBOR forward curve as of Dec. 31, 2018.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Many senior loans are illiquid, meaning that the investors may not be able to sell them quickly at a fair price and/or that the redemptions may be delayed due to illiquidity of the senior loans. The market for illiquid securities is more volatile than the market for liquid securities. The market for senior loans could be disrupted in the event of an economic downturn or a substantial increase or decrease in interest rates. Senior loans, like most other debt obligations, are subject to the risk of default.
This document is intended only for Professional Clients in Continental Europe, Dubai, Guernsey, Ireland, the Isle of Man, Jersey and the UK; in Hong Kong for Professional Investors, in Japan for Qualified Institutional Investors; in Switzerland for Qualified Investors; in Taiwan for Qualified Institutional Investors only; in Singapore for Institutional/Accredited Investors, in New Zealand for wholesale investors (as defined in the Financial Markets Conduct Act), and in Australia and the USA for Institutional Investors. In Canada, the document is intended only for accredited investors as defined under National Instrument 45-106. In Chile, Panama and Peru, the document is for one-to-one institutional investors only. It is not intended for and should not be distributed to, or relied upon, by the public.
For the distribution of this document, Continental Europe is defined as Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Spain and Sweden.
All data provided by Invesco unless otherwise noted. All data is US dollar and as of Dec. 31, 2018, unless otherwise noted. By accepting this document, you consent to communicate with us in English, unless you inform us otherwise.
This document is written, unless otherwise stated, by Invesco professionals. The opinions expressed herein are based upon current market conditions and are subject to change without notice. This document does not form part of any prospectus. This document contains general information only and does not take into account individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. Neither Invesco Ltd. nor any of its member companies guarantee the return of capital, distribution of income or the performance of any fund or strategy. Past performance is not a guide to future returns. This document is not an invitation to subscribe for shares in a fund nor is it to be construed as an offer to buy or sell any financial instruments. As with all investments, there are associated inherent risks. This document is by way of information only. Asset management services are provided by Invesco in accordance with appropriate local legislation and regulations.
This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell financial instruments.
This article is issued:
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.