Senior Loans are a “Go To” Income Vehicle when Rates Rise
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View from the Observation Deck

  1. Income-oriented investors have a broad universe of investment-grade debt securities to choose from when the U.S. economy is weak or in recession.
  2. Investors naturally tend to gravitate towards investment-grade debt (BBB or higher) in an effort to minimize credit risk.
  3. But what about interest rate risk? Where do investors concerned about preserving capital "go to" when rates are rising?
  4. Ironically, the universe of debt securities built to perform well when interest rates rise is far less expansive and the choices usually require investors to assume more credit risk.
  5. One such option is senior loans. Senior loans, which are issued by corporations and rated speculative-grade in quality (BB and below), are worth consideration, in our opinion.
  6. The interest paid by senior loans is not fixed, it floats. The loans are usually indexed to the 3-month LIBOR rate (average rate London banks charge each other for loans).
  7. Historically speaking, it tends to track the direction of the federal funds rate in the U.S. These two lending rates have been at historically low levels for the past three years.
  8. Senior loans sit at the top of the corporate capital structure, which typically means first claims on the assets of the issuer in bankruptcy proceedings.
  9. Again, senior loans are best suited for economic expansions, not times of crisis (see 2008 -2009 in chart). Investors should monitor the economy even after committing their capital.
Posted on Tuesday, May 22, 2012 @ 4:54 PM

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.