Our “Off The Wall” Blog
is now Monument #Unfiltered

Subscribe below to receive our unique, straight-forward, unfiltered wealth advice delivered straight to your inbox.

3 Risks of Investing in Bank Loans

3 Risks of Investing in Bank Loans

With interest rates rising in the bond market, fixed income investments are losing value. Bank loan yields rise with prevailing rates, but have a few downsides.

Bank loans might be a worthy investment in your overall portfolio. The asset class has a relatively stable return profile, they pay a coupon that rises as interest rates rise (and falls as interest rates fall) and they are the first in line to recover losses if a borrower defaults. But there are risk factors to consider when investing in bank loans.

The advantage of bank loans is that they may lower a plain vanilla portfolio’s overall interest rate risk and volatility. However, being the smart investor you are, you know that no investment is without its trade-offs, and bank loans are no exception. Here are three items to be wary of when considering investing in bank loans.

1. Reinvestment Risk.

Any bond that pays interest is subject to reinvestment risk, the chance that the income paid to the bondholder will provide less yield if prevailing rates go lower. This applies to both fixed rate and floating rate bonds, but it has a larger impact on floating issues such as bank loans. If interest rates fall, then not only do bank loan investors have to reinvest at lower rates, but they also have a smaller and smaller amount to reinvest.

Consider the following hypothetical situation. Someone buys a bank loan when interest rates are at 5 percent, and the following quarter they fall to 4.5 percent. This bank loan investor will need to settle for a half percentage point less on the new investment, and the following quarter there is that much less to reinvest. This becomes a big factor when rates are falling: Smaller amounts of income to invest and lower yields the reduced capital.

2. Liquidity Risk. 

The bank loan market has only been around for two decades, so there isn’t a large amount of history within this asset class. The track record so far shows there just aren’t as many buyers and sellers when compared to the high yield market or the investment grade market. Because of the relatively low number of  participants, bank loan investors may not be able to find a buyer or seller when they want, even in normal times. In times of stress, especially, it can lead to big price discrepancies for those who wish to buy or sell. The reasoning behind this is straightforward: The laws of supply and demand dictate that when there are more sellers than buyers, like there were in the 2008 stock market collapse, the price of the item will drop. Additionally, illiquid markets are exposed to the risk of significant swings in price whenever an unusually large trade is placed. If a large institution wanted to liquidate a big bank loan position it could put downward pressure on pricing.

3. Non-Normal Returns.

By non-normal, I don’t mean weird or strange. This is actually a fancy statistical way of saying that investors could experience an unusual return, which could be negative or positive. When its a positive return like the 8 percent paid on bank loans in one month back in April of 2009, most people view this as a good thing. But the opposite can occur, as well. For example, in October of 2008, when investors were getting hit with margin calls and were selling out of everything they owned all at once, bank loans dropped by 13.0 percent. That’s rather sizable considering monthly fluctuations are usually more like 0.5 percent to 1.5 percent. The lack of depth in the bank loan market may result in unexpectedly large negative returns.

Despite these downsides, bank loans can be a great diversifier within a portfolio when rates are rising. It depends on how you structure your income portfolio and your willingness to deal with the risk of falling interest rates or being stuck with an asset that can lose value as many buyers disappear in times of stress. I’ll let you weigh the pros and cons.

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 >

Get Monument #Unfiltered: Our Free Private Wealth Newsletter

Our no B.S. wealth advice delivered 2x per month, max. Tuned specifically for busy, high-net-worth business professionals and investors who want straightforward advice without the fluff.


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 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.