The case for leveraged loans

Leveraged loans are the senior-most debt obligations of non-investment grade corporate borrowers and are an attractive source for uncorrelated returns, argue David Frey and Julian Qin, of Highbridge Principal Strategies.

In this paper, they argue that because such loans blend the current income and contractual principal payment of traditional fixed-income securities with a logical hedge against rising interest rates and inflation, these loans represent a unique asset class for investors, especially during the current period of historically low interest rates.

While investors are increasingly interested in corporate credit, many are participating through the bond market, which includes an imbedded interest rate bet. Because loans are floating rate, they have minimal interest rate duration.

A further benefit to loan investors is the low correlation of loan returns to bonds and equities, which is helpful in diversifying risk and enhancing the overall expected returns of a portfolio.

Even more impressively, they say, except during the extraordinary and abnormal events of the recent credit crisis, leveraged loans have generated better risk-adjusted returns than many other asset classes, as evidenced by their higher Sharpe ratios.

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