Myths and Legends: European Broadly Syndicated Loans

Broadly Syndicated Loans (BSL) have evolved significantly over the past two decades, shaped by economic cycles, regulatory changes, and shifting investor demands. A fundamental strength of syndicated loans lies in their floating rate structure. These loans are typically linked to benchmark interest rates, providing natural inflation protection and mitigating interest rate risk, a significant advantage amid uncertain or rising rates.

Allocations to the European loan market can also facilitate geographic and sectoral diversification. It includes a wide array of issuers from multiple countries and sectors, many of whom exhibit solid financials with resilient earnings. Supportive financing conditions and a liquid buoyant secondary market can further enhance their attractiveness by enabling active portfolio management.

However, potential risks such as credit defaults and economic downturns can be mitigated through active management with an established and trusted GP. Careful due diligence and portfolio construction alongside a highly experienced active manager is essential to successfully capture opportunities in this area. Despite growing popularity, leveraged loans face persistent myths. Here, we will explore the origins of and opportunities in the market, while dispelling common myths surrounding syndicated loans and their role in investment portfolios.

A brief history of an epic journey

In the early 2000s broadly syndicated loan instruments were a largely unknown asset class primarily used for leveraged buyouts (LBOs), mergers, and acquisitions. Banks still dominated the market, but non-bank lenders had nonetheless started gaining traction at this time. Following the Global Financial Crisis (GFC) in 2008, credit markets saw a sharp decline as access to funding tightened and defaults surged. Recovery rates on first-lien bank loans averaged 63% in that period vs 33% for high-yield bonds according to data from Moody’s Syndicated Bank Loans 2008 review. The market remained largely functional and from 2010 onwards the leveraged loan market “fixed income’s best kept secret”, expanded rapidly from €205bn to €408bn as investors were attracted by its seniority and typically stable income driven return profile.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested.
Whenever mentioned, past performance is not a guide to future performance.
The views expressed in this document should not be taken as a recommendation, advice or forecast.

Leveraged loan myths: debunked

Myth 1: Risk is not appropriately compensated

Borrower profiles in the sub-investment grade market are typically perceived as at a higher risk of default. However, syndicated loans (a largely Single-B rated asset class) have historically delivered lower defaults relative to public high yield bonds (an ostensibly BB rated asset class.)*

The elevated risk can be well compensated through active management, which focusses on avoiding losers to minimise potential principal erosion, particularly during a market downturn.

*Source: S&P UBS Western European Leverage Loan Index, ICE BofA European Currency Non-Financial High Yield 2% Constrained Index (HPIC)

Myth 2: Leveraged loans are only attractive when rates are higher

It is a common misconception that leveraged loans may not be as compelling in low-rate environments as they deliver steady attractive rates of income when rates are rising. However, even in a declining rate environment, they still usually offer reliable streams of income and normally remain less sensitive to rate fluctuations than traditional asset classes. This is especially true of loans that have a conservative, senior-only, floating-rate strategy with a base interest rate floor embedded preventing yield erosion even in a low base rate environment.

Myth 3: Loans are a small, niche universe

It is widely believed that the loan market is relatively small in comparison to the HY bond universe. However, the European leveraged loan asset class has experienced significant growth over the past decade, with its market doubling since 2010 and quadrupling since 2005. The market has reached €408bn, larger than the size of the European high yield market (€350bn).

Myth 4: Loans only cater to one return profile

Contrary to widespread belief, loans can cater to various risk and return profiles across the liquidity spectrum. This ranges from investment grade CLO Senior debt at the lower, liquid end of the spectrum (typically targeting IRR -3-5%) to CLO mezzanine and CLO equity offering equity-like returns (typically targeting IRR from 8-13%)*. European leveraged loans sit somewhere in the middle targeting returns of around 5-8% with strong liquidity, but the comparative risks are usually significantly lower.

Myth 5: All European loan mutual funds were launched post Global Financial Crisis (GFC).

There is a widespread view that all European loan mutual funds were launched as a reaction to the fall-out from the GFC. M&G was one of the first GPs to present its European loan fund to market prior to the crisis – the first European loan fund of its kind with the benefit of a 20-year track record.

Legend: M&G European Loan Fund

In our view, the M&G European Loan Fund (ELF) is a noteworthy example of the resilience of this asset class. The fund is currently a €2bn, monthly-dealing mutual fund, established in 2005, investing in senior secured loans and notes. The fund lends first lien only to sub-investment grade companies, so stock-picking and a robust credit process are essential features of its success. Returns are largely delivered from running income, enhanced by Original Issue Discounts (OIDs) and discounted secondary market entry alongside rate-fixing ‘floors’.

M&G European Loan Fund

Investment policy: The fund intends to achieve its investment objective by investing principally in a diversified portfolio of leveraged loans and subparticipations in leveraged loans. The fund may also invest in senior secured floating rate notes (being public bond issues that possess similar structural features and security to senior leveraged loans). The investment objective of the fund is to create attractive levels of current income for investors, while maintaining relatively low volatility of Net Asset Value.

The main risks associated with this fund: The value and income from the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested.

Credit Risk: the possibility that a debtor will not meet their repayment obligations. Liquidity Risk: where market conditions make it hard to sell the fund’s investments at a fair price to meet redemptions, we may suspend dealing in the fund’s units.

Prepayment Risk: loans may be prepaid by issuers at short notice, as a result it may be difficult for the fund to locate and reinvest capital at an attractive price or at all, which may affect the fund adversely.

Please note, investing in this fund means acquiring units or shares in a fund, and not in a given underlying asset such as a building or shares of a company, as these are only the underlying assets owned by the fund. This is not an exhaustive list, you should ensure you understand the risk profile of the products or services you plan to purchase. Further details of the risks that apply to the fund can be found in the fund's Prospectus.

Sustainability information: The fund promotes Environmental/Social (E/S) characteristics and while it does not have as its objective a sustainable investment, it will have a minimum proportion of 20% of sustainable investments. You can find the fund’s sustainability-related disclosures on the M&G website.