Investors looking to boost their portfolio should consider allocating some funds to U.S. senior loans, according to Nuveen. The assets are debt instruments issued by well-known companies, like American Airlines and Burger King-parent Restaurant Brands , that are considered below investment grade. They are structured and syndicated by banks to large groups of lenders, such as mutual funds and institutional investors. Senior loans — which are also referred to as syndicated loans, floating rate loans or bank loans — typically have floating interest rates tied to the Secured Overnight Financing Rate (SOFR). These days, those yields can top 8%. The Bloomberg U.S. Leveraged Loan Index, which has a coupon of 7.99%, currently has a yield to maturity of 8.5%, and a yield to 3-year of 8.63%, Nuveen pointed out. “It’s a very powerful asset class in a lot of different ways,” Scott Caraher, the firm’s head of senior loans, said in an interview. “You’re not taking any interest rate or duration risk.” There is credit risk involved, which means investors should carefully consider issuers, he said. However, senior loans are at the top of the capital structure, he noted. “If something goes wrong, we’re first in line to get repaid,” Caraher said. While the Federal Reserve is expected to reduce interest rates further this year, the allocation works in all interest-rate environments, he said. “You can’t time the markets,” Caraher said. “It really should be a permanent allocation, just like investment-grade or high-yield [bonds].” Here are the five reasons Nuveen said it is bullish on senior loans. 1. Compelling risk-adjusted return From a yield-per-duration perspective, senior loans have one of the highest yields in fixed income, with low sensitivity to interest rates, Nuveen wrote in a December note. Plus, the Sharpe ratio — which is a measure of risk-adjusted return — shows they have the highest risk-adjusted return of any fixed-income asset class, the firm’s analysis of Morningstar data found. 2. They are resilient The U.S. loan market produced positive returns in 28 out of the last 31 years, Nuveen pointed out. In addition, contrary to the perception that rising rate environments are attractive for senior loans, the assets had positive total returns in eight out of nine years when the Fed cut rates, the firm said, citing Bloomberg data. 3. Offers portfolio diversification Senior loans have lower correlations to other major asset classes, Nuveen said. For example, they have a correlation of just 0.15 to high-quality U.S. bonds and 0.60 to U.S. equities, it said. In comparison, high-yield bonds have correlations of 0.48 and 0.80 to high-quality bonds and stocks, respectively, the firm pointed out. Therefore, an allocation to senior loans can increase portfolio returns while reducing volatility, Nuveen argues. 4. Liquidity provides flexibility The loans trade actively on the secondary market. That liquidity means portfolio managers can trade positions to either mitigate risk or seek returns, Nuveen said. Investors can also allocate assets in real time instead of being locked up in multiyear assets, it said. 5. They’ve become mainstream U.S. loans have reached a $1.4 trillion market size, considerably larger than some other fixed-income classes that are considered mainstay in portfolios, including emerging-market debt, Nuveen said. That rise has been fueled by the issuance of collateralized loan obligations (CLOs), which now make up about two-thirds of the investor base, it added. Institutional investors comprise about 30% of the buyer base, which brings stability to the market, it added. What to look for Individual investors can get access to senior loans largely through exchange-traded funds and mutual funds, both open- and closed-ended. For instance, the T. Rowe Price Floating Rate ETF is rated Gold by Morningstar. It has a 7.32% 30-day SEC yield and 0.61% expense ratio. TFLR 1Y mountain T. Rowe Price Floating Rate ETF When choosing a fund, it’s important to focus on who is running it, said Tom Graff, chief investment officer at Facet Wealth. “You want a team that has a lot of experience in this area,” he said. See how they did during down times in the market, like in 2008, and whether they were aggressive or a bit safer in their investments, he said. “Neither is right or wrong, but you should know what you are getting into,” he said. Also pay attention to the credit rating allocations within the fund, as well as how much exposure the fund may have to senior loans and other assets, like high-yield bonds and CLOs, Graff said. In addition, be aware of any fees charged, including a performance fee, which can eat away at your returns, he said. Nuveen’s Caraher also said active management is important because managers can identify and manage risks. “Over… the last 20 years, the default rate has been about 3% a year,” he said. “A good manager can get that down to about 1[%] to 1.5%.” He believes the best way to access senior loans is through an open-end, daily-liquidity mutual fund, like the Nuveen Floating Rate Income Fund. It has a 30-day SEC yield of 7.74% and 0.78% expense ratio. About 85% of the fund is loans that are actively managed on a daily basis and about 15% high-yield bonds, Caraher said. NFRIX 1Y mountain Nuveen Floating Rate Income Fund Senior loans can make up anywhere from 5% to 15% of your overall fixed-income exposure, he said. “It’s the only fixed income asset class that does not have duration, and right now, it has arguably the highest yield of any liquid fixed income asset class,” he said. “We believe, based on all of these things, it should probably be skewed a little bit to the higher end of that range.” Facet Wealth’s Graff said senior loans can take the place of some of a portfolio’s high-yield allocation. “It is a good complement,” he said. “It can be lower risk, both in terms of higher in the capital structure and floating rate,” he said.
