Secured Credit Insight: secured loans — the hidden benefit of negative rates

05/09/2019

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​In this short view from the Secured Credit desk, Oliver Bardot, Associate Portfolio Manager within the Secured Loans Team, briefly outlines the distinctive aspects of the European and US loan markets, exploring the impact of negative interest rates in Europe on loan prices in this market.


The leveraged loan market has been in the crosshairs of regulators and central bankers across the globe in 2019. Despite that, both the US and European loan markets have remained stable and delivered healthy returns year-to-date, up 5.4% and 4.7% respectively in the first half of 2019 (hedged to USD). Although the two markets are closely related, there are areas in which the two diverge to some extent. With this in mind, we thought it worthwhile to highlight a peculiar feature of the loan market that is currently benefiting investors in European loans.

Big is not always best
It is well-known that the US loan universe is significantly larger and more diverse than its European counterpart. At the end of June, the US market was made up of 1,657 issues totalling almost $1,250bn of outstanding loans. This is around four times the size of its European counterpart on either measure. While there is some overlap between the two markets, many of the issuers are unique to the European universe, increasing diversification for global loan investors.

Crucially, while Europe is an ‘institutional’ only market — collateralised loan obligations (CLOs) and credit funds dominate — the US market is also open to retail investors, who currently account for around one fifth of that market. This additional source of demand can lead to increased volatility. In mid-August, leveraged loan mutual funds (investing in loans that enable retail investors to access the loan market) were in the middle of a 36-week streak of outflows, the longest period of consecutive withdrawals the asset class has experienced.

The floor rules
One of the drivers of these outflows from US loan mutual funds has undoubtedly been the dramatic shift in expectations around the trajectory of US interest rates as the US Federal Reserve (Fed) pivoted to a more accommodative stance. As loans typically pay a fixed spread over Libor, a decline in interest rates expectations will likely feed through into lower loan coupon payments.

On the other hand, and somewhat counterintuitively, European loan investors are currently benefiting from the negative interest rate environment across much of Europe. This is due to the language in loan documentation setting a zero per cent floor on Euribor for the purposes of calculating loan coupons. As the European Central Bank’s main interest rate (the deposit facility) is at -0.4%, European loan investors are benefiting from almost 40 basis points of additional spread because of the floor. For non-euro investors hedging back into their local currencies the effective spread is therefore increased once the floor benefit is factored in. 

While US loans also benefit from floors, typically set between zero and 1%, given that US Libor currently stands above 2%, the floor does not benefit loan coupons at present. Looking at current expectations for interest rates in Europe in the chart below, this floor is likely to become increasingly valuable.

Euro interest rate futures signal decline in euro rates ahead  


Source: Bloomberg, futures curves drawn from 3-month Euribor and 6-month standard forward rate agreements (FRAs) for various tenors, data as at 1 August and 20 August 2019 (current)

Closing thoughts
There are of course other differences to be aware of, including differences in credit and covenant quality, as well as the varying insolvency regimes across Europe. However, the benefit of the interest rate floor, as well as the aforementioned restrictions on retail investment, have contributed to the lower historic volatility of the European market. When looking at risk-adjusted returns, the 5-year Sharpe ratio in Europe stands at 1.81 versus 0.96 for the US market (as at 30 June 2019). While past performance is no guide to future performance, we believe investors could benefit from the increased diversification that an allocation to European loans brings.



These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Janus Henderson Horizon Total Return Bond Fund

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Janus Henderson Institutional High Alpha Credit Fund

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  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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Janus Henderson Institutional High Alpha Gilt Fund

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  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • Callable debt securities (securities whose issuers have the right to pay off the security’s principal before the maturity date), such as ABS or MBS, can be impacted from prepayment or extension of maturity. The value of your investment may fall as a result.

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Specific risks

  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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