Viewpoint  |  March 19, 2024

Global Syndicated Loans: Four reasons the asset class could outperform again in 2024

The global syndicated loan market enjoyed a strong 2023 as high coupons and price appreciation combined to generate double-digit returns, which outweighed unfounded fears about fundamentals.

Assuming a similar macro environment, we believe the asset class can again deliver strong absolute and relative performance for four main reasons, even if the potential for price appreciation is diminished.

High coupons unlikely to disappear in the medium term

The floating-rate coupons paid on syndicated loans have driven recent performance. Whilst market participants continue to debate when central bank interest-rate cuts might arrive, loan investors have enjoyed instant access to higher base rates. These have risen steadily in the past two years and been largely unaffected by short-term rate volatility. Today, base rates used for loan coupon calculations sit at 3.9% for three-month Euribor in Europe and 5.3% for three-month SOFR in the US.

Fig. 1 – European (CSWELLI) and US (CS LLI) leveraged loan coupons: March 2019 – January 2024

Source: Credit Suisse, as of 29th February 2024. For illustrative purposes only.

In 2023, the Credit Suisse Western European Leveraged Loan Index (CS WELLI) returned a consistent 2-4% per quarter, while the same was true for the Credit Suisse Leveraged Loan Index (CS LLI), the US equivalent, at approximately 3% per quarter. These returns were underpinned by an average coupon in 2023 of 7.7% for CS WELLI and 8.9% for CS LLI (Figure 1). With recent data points suggesting ongoing strength in the global economy, and inflationary pressures not easing as fast as they did in 2023, we believe loan investors can continue to benefit from high coupons this year.

Fig. 2 – Annualised asset class returns and volatility 2018-2023

Returns

Past performance is not a reliable indicator of current or future results.

Volatility

Source: Credit Suisse and ICE Index Platform. Data as of December 31, 2023. Credit Suisse Leveraged Loans Index (CSLLI); Credit Suisse Western European Leveraged Loans Index (CS WELLI); ICE BofA US Cash Pay High Yield Index (J0A0); ICE BofA Euro High Yield Index (HE00); ICE BofA US Corporate Index (C0A0); ICE BofA Euro Corporate Index (ER00); ICE BofA US Treasury Index (G0Q0); and ICE BofA German Government Bond Index (G0D0). Non-dollar indices have been hedged to USD. Indices selected are best available proxies for the respective sub-asset classes. Index performance is for illustrative purposes only. You cannot invest directly in the index. See ‘Important Information’ for further details on CS WELLI. Muzinich views and opinions for illustrative purposes only, not to be construed as investment advice

Institutional technicals diminish volatility

Unlike other public markets, regulatory restrictions mean the investor base of the global loans market is almost exclusively institutional. The US market has fewer restrictions, but retail mutual funds only account for around 6%.¹ Two thirds of outstanding global syndicated loans are held by closed-ended collaterised loan obligations (CLOs).²

Fig. 3 – Outstanding US CLOs

Source JP Morgan, Bloomberg Finance LP, as of 5th February 2024. For illustrative purposes only, not to be construed as investment advice.

Fig. 4 – Outstanding European Collateralised Loan Obligations 2013 - 2024

Source JP Morgan, Bloomberg Finance LP, as of 5th February 2024. For illustrative purposes only, not to be construed as investment advice.

At the top of the capital structure (AAA demand), changes to regulation, repayment of existing holdings and a desire to have high-quality securities without interest-rate duration have seen banks return to the market. At the other end of the capital structure (equity demand), EU risk-retention rules have led to a surge in captive CLO equity funds, which allow CLO managers to issue at times of their choosing, as well as solving regulatory issues.

According to LCD³, January and February represented the fastest start to a year for CLO issuance in the post-financial crisis era, suggesting this could be a strong year for the asset class.

Limited M&A supply

M&A activity continues to be stymied by high rates, which put pressure on the expected internal rates of return for private equity firms and cause a bid/ offer standoff between buyers and sellers of businesses. As such, the supply side of the technical equation remains constrained, at the same time as demand is increasing.

In the absence of significant M&A, the market has turned to refinancing and pushing out maturities, which were a concern for some investors when markets experienced volatility in 2022. As Figure 5 shows, near-term maturities have been largely refinanced through syndicated loans, high-yield bonds and the private credit market (although recent syndicated loan new issue activity suggests some reversal of the trend in private credit).

Fig. 5 – Global maturity wall (US$bn)

Forecasts mentioned are not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy

Source: Pitchbook LCD Global Report – US/Europe, as of 31st December 2023.. Morningstar indexes draw on a database of over 85,000 loans, providing comprehensive coverage of the global market.

Resilience of fundamentals

Syndicated loans continue to exhibit strong fundamentals. Whilst higher rates and their potential to pressure cashflows have been a concern over the last two years, this ignores the fact most leveraged loan issuers had taken steps to hedge interest-rate risk. There are no definitive statistics on this, but based on our conversations with borrowers, we believe many have taken pre-emptive action to mitigate this risk. Interest coverage ratios have therefore not been unduly pressured.

In the event of an economic ‘soft landing’, we would not expect default rates to jump materially from their long-term averages at which they currently sit in Europe and the US.

Furthermore, the market has pre-emptively identified likely default candidates and priced them accordingly, so we believe the impact on loan performance is likely to be minimal.

Absent a major economic downturn, which would affect all risk assets, we expect loan fundamentals to remain strong.

Fig. 6 – Sub-investment grade default trends and forecasts

Forecasts mentioned are not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.

Source: Moody’s Investors Service, as of December 31st, 2023. Updated quarterly. Default and Recovery Rates of European Financial and Non- Financial Corporate Issuers. Europe Trailing 12-Month Issuer –Weighted Spec-Grade Default Rate Forecast and Global Trailing 12-Month Issuer-Weighted Spec-Grade Default Rate Forecast. Figures up to and including March 2023 exclude Russian corporates from the default rates. Figures from April 2023 onwards include Russian corporates. Muzinich views and opinion for illustrative purposes only, not to be construed as investment advice.

1 & 2. JP Morgan, ‘US High Yield and Leveraged Loan Strategy’, March 15, 2024

3. LCD, ‘Global CLO Roundup’, March 12, 2024

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of March 2024 and may change without notice.

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Index Descriptions

CSWELLI - The CS Western European Leveraged Loan Index is designed to mirror the investable universe of the Western European leveraged loan market. Loans denominated in US dollar or Western European Currencies are eligible for inclusion. The index is rebalanced monthly on the last business day of the month instead of daily. Qualifying loans must have minimum outstanding balance of $100 million (in local currency), issuers with assets located in or revenues derived from Western Europe, at least one year long tenor, be rated “5B” or lower, fully funded and priced by a third party vendor at month-end.

CS LLI - The CS Leveraged Loan Index is designed to mirror the investable universe of US dollar denominated leveraged loan market.  The index is rebalanced monthly on the last business day of the month instead of daily. Qualifying loans must have a minimum outstanding balance of $100 million for all facilities except TL A facilities (TL A facilities need a minimum outstanding balance of $1 billion), issuers domiciled in developed countries, at least one year long tenor, be rated “5B” or lower, fully funded and priced by a third party vendor at month-end.

LSTA Leveraged Loan Index – The LSTA Leveraged Loan Index is a market value-weighted index designed to measure the performance of the US leveraged loan market based upon market weightings, spreads and interest payments.

Morningstar European Leveraged Loan Index The Morningstar European Leveraged Loan Index is a market-value weighted multi-currency index designed to measure the performance of the European leveraged loan market.

J0A0 - The ICE BofA ML US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period that is publicly issued in the US domestic market.  Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

HE00 - The ICE BofA ML Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.  

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

ER00 – The ICE BofA ML Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million. 

G0Q0 – The ICE BofA ML US Treasury Index tracks the performance of US dollar denominated sovereign debt publicly issued by the US government in its domestic market. Qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule, a minimum amount outstanding of $1 billion and at least 18 months to final maturity at the time of issuance.

G0D0 – The ICE BofA ML German Government Index tracks the performance of EUR denominated sovereign debt publicly issued by the German government in the German domestic or Eurobond market. Qualifying securities must have at least 18 months to maturity at point of issuance, at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 1 billion.

Index performance is for illustrative purposes only. You cannot invest directly in the index.

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