1) Loans are often overlooked when investors are hunting for yield. Why is that, and how do loan yields compare to other categories?
We think investors have been taught to think of loans as a bet on rising rates, while high yield bonds are typically viewed as a yield play and investment grade (IG) corporates are often considered a safer choice with a lower yield. But with rates expected to be low for a while, we think income-focused investors should view loans as one of several yield plays. Loans typically have short average lives, so when they are priced at a discount, their yields can be similar to or greater than the yields on high yield bonds priced over par. And while IG corporates may have little credit risk compared to high yield, when rates are this low, they typically offer limited yield and have relatively high interest rate risk. Loans have a floating coupon, so they currently offer an advantage in both yield potential and rate risk over investment grade bonds. Meanwhile, loans’ seniority and security make them structurally more insulated from credit risk than most high yield bonds. We think loans deserve a place in any investor's hunt for yield.
2) Loans’ default rates have been lower than many expected in 2020. What are you expecting in 2021?
Default rates across credit were generally lower than people feared, but that does not imply the pandemic was not a big economic shock. In our view, default rates were lower because the companies in the syndicated loan market and the high yield market are typically large enough to have levers they can pull—such as high cash balances, revolving lines of credit and cost cuts—to gain the liquidity needed to get through a short, sharp downturn. We think investors may have thought loans were going to small companies. However, most borrowers in the loan market are actually quite large, and large companies mostly did surprisingly well in 2020.