The Takeaway
The European leveraged loan market has grown significantly, as it has in the US. A range of industries and geographies are represented in the Morningstar European Leveraged Loan Index. Financing demand from private equity-backed borrowers and buying demand from collateralized loan obligations are key catalysts for growth. Some investors use the asset class as a parking lot for private credit allocations.
Thanks to higher interest rates, the Morningstar European Leveraged Loan Index's yield to maturity exceeds that of the Morningstar Eurozone High-Yield Bond Index by roughly 2 percentage points.
Credit risk is a feature of the asset class. The Morningstar European Leveraged Loan Index's credit-quality profile is lower than that of its high-yield bond counterpart, and it has unsurprisingly declined sharply in periods of economic stress. That said, overall volatility has been lower than that of high-yield bonds, and leveraged loans' low correlation with equities and government bonds gives them diversification appeal.
Once a niche asset class, bank loans have entered the mainstream. Measured by the Morningstar European Leveraged Loan Index, the market value for broadly syndicated loans, typically structured as senior secured corporate debt, has more than tripled over the past decade. In the US, the asset class is now larger than high-yield bonds, while in Europe, the two markets are now of similar size. The comparison is relevant because leveraged loans share many characteristics with sub-investment-grade corporate debt. Both are favorites of credit investors.
There are key differences between the two asset classes, though, which have important implications. Leveraged loans are floating-rate in nature, whereas high-yield bonds typically have fixed-rate coupons, making them more price-sensitive to shifts in the yield curve. So, when central banks started hiking interest rates in 2022 and government-bond yields followed suit, the Morningstar Eurozone High-Yield Bond Index declined nearly 11% on a total-return basis. By contrast, the European Leveraged Loan Index lost 3.5% that year. Meanwhile, leveraged-loan yields surpassed 9% at one point.
Bank loans are not without risk. Their economic sensitivity was on display during the global financial crisis 15 years ago, as well as in March 2020 during the "pandemic panic." That said, loans are interesting from a diversification perspective. Though many investors like to allocate to the asset class tactically, there's reason to consider a strategic allocation.
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