June loan rally signals asset class could see outsized returns as rates stay high

Hugh Minch

Senior reporter

Leveraged loans enjoyed their second-best month of the year in June, with the asset class returning over 2% on the month as Creditflux goes to press. Loans have generated a return of 5.8% year-to-date, with only January’s 2.9% topping the numbers for June.

The rally followed the Federal Reserve’s decision at the start of the month not to raise interest rates (although it suggested further rises may come later in the year), and was seen across risk assets, with the loan market tracking close to the S&P 500.

In a research paper published in late June, Bank of America’s credit strategists Neha Khoda and Dong Ba said that evidence was mounting against a recession and that loans could see returns in excess of 10% in 2023 as a consequence, outperforming other fixed income asset classes.

“We are tactically bullish and expect the loan market to grind tighter towards our $95 soft landing target,” BofA’s analysts wrote. “We think double and single Bs could gain one point each, while triple Cs may have three points of upside.

“Interest rates will likely remain elevated for five to 10 years”

Howard Marks, Co-chairman | Oaktree Capital Management

“Even so, we expect higher-quality loans to outperform on a risk-adjusted basis this year and next,” they added.

While the technical picture for the loan market improved in June, fundamentals still remain the biggest challenge facing the asset class.

“In the face of higher for longer rates, we expect defaults to increase and downgrades to remain elevated in 2024,” wrote Khoda and Ba. “An economic soft landing is not a panacea for fundamental woes emerging from untenable capital structures — it primarily solves for lower mark-to-market losses on an index level even as default pressures increase disproportionately among lower-quality issuers.”

The duration of the higher rate environment was the source of speculation among investors in June. The Federal Reserve said it would not cut rates this year.

Speaking on an internal company podcast named The Insight, Oaktree Capital Management co-chairman Howard Marks said that interest rates would likely remain elevated for five to 10 years.

“You can potentially get equity-type returns from fixed income on a contractual, more reliable basis,” Marks said.

Share this article:

${prev-page}

${next-page}

Browse more Creditflux newsletters

Global credit funds & CLO's

July 2023 | Issue 256

Published in London & New York.