Explore Our
“Off The Wall” Blog

Unique, straight-forward, unfiltered opinion on topics of concern for individuals with newfound wealth.

3 Reasons to Love Bank Loans

3 Reasons to Love Bank Loans

There is a sub-sector within the bond market that is getting quite a bit of attention lately: floating rate bond funds. These funds may also be known as senior secured loans, bank loans or leveraged loans. Going forward, I’ll refer to them as bank loans just to keep things simple, but given their unique characteristics, it’s worth looking at them in more detail. Here are three reasons why bank loans may be a good fit in your portfolio relative to investment grade and high yield bonds:

1. Low interest rate risk. With traditional bonds, investors receive a fixed coupon payment on a set schedule (hence the term “fixed income”) and the value of the bond fluctuates as interest rates move. When interest rates go up, the price of bonds fall, and when interest rates fall, bond prices increase. This is at the heart of what interest rate risk is: it’s the risk that bond values adversely change due to fluctuating interest rates.

That relationship between interest rates and price doesn’t exist with bank loans, which is what makes them attractive to investors now. The coupon on bank loans is variable as it resets to the current interest rate every three months keeping its price at or near par. Sure, the price can trade at a premium or a discount before the coupon resets, but overall, bank loan prices are fairly stable despite changes in market rates.

2. High recovery rates. Typically, bank loans are issued by non-investment grade companies, so you can think of them as the floating rate version of high yield. As is the case with any entity that issues a bond, an investor must evaluate the creditworthiness of the borrower and determine two key items: the likelihood of default and the recovery rate in the event of default. It should go without saying that, all else being equal, you want to find a borrower (or an investment) with a low chance of defaulting or make sure you get as much of your investment back as possible if they do.

On one side of the bond spectrum you have investment grade with very low probabilities of default. In the corporate world, these issuers are large companies with steady cash flow and little chance of not being able to make their interest payments each month. On the other side you have high yield with much higher rates of default. While bank loans are closer to high yield bonds in terms of credit risk, they have a unique feature which results in much higher recovery rates. Holders of bank loans are the first group of people to get paid if the borrower goes bankrupt because the loan is backed by company assets. Bank loans get an extra layer of protection not offered by high yield debt because of their seniority in line to get some of their money back.

3. Less volatile returns. A common way to assess risk is to look at how volatile the returns have been over time using a statistical measure called standard deviation. What you need to keep in mind is that the larger the standard deviation of returns, the higher the volatility of the investment and the greater the chance that you could suffer a big loss. Prior to the 2008 financial crisis, the standard deviation of bank loans was 2.3 percent. To put this number into perspective, U.S. stocks have a standard deviation of around 20 percent, high yield has a standard deviation of 8.6 percent and investment grade has a standard deviation of 5.5 percent. In other words, bank loans were an extremely stable asset class. That isn’t to say that you couldn’t lose money, but you weren’t going to suffer any crippling losses.

Even if you include returns post-2008, that number only increases to 5.4 percent, which is still slightly below investment grade and well below high yield. Who would have guessed that there was a segment of the fixed income universe that had lower volatility than investment grade?

The bottom line: Because of their floating-rate nature, their priority over other investors in recovering potential losses and their relatively stable return profile, bank loans may provide a diversification benefit to a bond portfolio by lowering interest rate risk and volatility.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for individual. To determine which investment is appropriate please consult your financial advisor prior to investing. All performance referenced is historical and is not guarantee of future results. All indices are unmanaged and may not be invested into directly.

Read this article on U.S. News & World Report…


Please remember that past performance is no guarantee of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Monument Capital Management, LLC [“Monument”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Monument. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. No amount of prior experience or success should be construed that a certain level of results or satisfaction will be achieved if Monument is engaged, or continues to be engaged, to provide investment advisory services. Monument is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice.

A copy of the Monument’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.monumentwealthmanagement.com/disclosures. Please Note: Monument does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Monument’s website or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.  It should not be assumed that your Monument account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Monument accounts; and, (3) a description of each comparative benchmark/index is available upon request.

Please Remember: If you are a Monument client, please contact Monument, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.  Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. Please Also Remember to advise us if you have not been receiving account statements (at least quarterly) from the account custodian.

Stay up to date!

Subscribe to our “Off the Wall” Blog for articles and videos on all things wealth management, by all members of our Team. Unlike Facebook, we will never share your data with anyone.