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Returns plus Resilience? A Closer Look at Leveraged Finance

Returns plus Resilience? A Closer Look at Leveraged Finance

Today, with skyrocketing inflation and ongoing rate hikes sparking bond market declines, we expect to see ongoing investor interest in leveraged finance strategies: hybrid fixed income offerings that marry high yield bonds with leveraged loans, plus some securitised credit. Although their focus on lower-quality credits may seem problematic in a period of economic difficulty, leveraged finance strategies provide investors with three timely market advantages: diversification, low duration and tactical flexibility.

Returns plus Resilience? A Closer Look at Leveraged Finance


How do we define leveraged finance strategies? Leveraged finance strategies are part of the diverse multi-sector fixed income family and, as such, they are strategies that focus on a variety of sub-investment grade credit opportunities. At their heart, ‘leveraged finance’ strategies—which are founded on the complementary nature of high yield bonds and leveraged loans—represent a high-conviction approach to sub-investment grade credit.

What advantages do they offer relative to standalone allocations? Although leveraged finance managers tend to take more credit risk than their counterparts running standalone high yield bond strategies, they gain exposure to floating-rate assets and significantly reduced duration risk (often of less than one year). The floating rate exposure also provides a much-needed cushion in a rising rate environment.

Why should investors pay attention to these strategies now? Our detailed proprietary analysis has determined that these strategies can delivery both downside protection and meaningful upside returns in a variety of different environments, despite their focus on lower-quality credit. We also recognise, however, that leveraged finance strategies—while beneficial to portfolios—are not a panacea for investors as they contend with skyrocketing inflation and bond market declines.

Returns plus Resilience? A Closer Look at Leveraged Finance


Ten years ago, an investor seeking a diversified fixed income solution focused on higher-yielding strategies would have found only a handful of external managers with viable products. Today, following a period of unprecedented investor demand and market growth, we can find a plethora of hybrid, actively managed offerings that combine high yield bonds and leveraged loans in new ways.

Recent stock market movements are provoking closer scrutiny of characteristics such as volatility reduction, downside protection and style/sector exposures. In some cases, this scrutiny is the result of disappointment, with the underperformance of Quality strategies in 2022 providing a recent notable example.

In this paper, we use manager peer group analysis to highlight portfolio exposures, performance (including results in particular market conditions) and key differences between offerings. We also compare these strategies to peer groups of standalone high yield and leveraged loan strategies to scrutinise the benefits of combining the two asset classes in one solution.

Important Notices

This commentary is for institutional investors classified as Professional Clients as per FCA handbook rules COBS 3.5R. It does not constitute investment research, a financial promotion or a recommendation of any instrument, strategy or provider. The accuracy of information obtained from third parties has not been independently verified. Opinions not guarantees: the findings and opinions expressed herein are the intellectual property of bfinance and are subject to change; they are not intended to convey any guarantees as to the future performance of the investment products, asset classes, or capital markets discussed. The value of investments can go down as well as up.