The Takeaway
While leveraged loans and high-yield bonds both provide exposure to non-investment-grade instruments, a key distinction between the two asset classes is in their coupon payment structure: Leveraged loans are primarily floating in nature; high-yield bonds typically have fixed coupons.
Leveraged loans outperformed high-yield bonds during rate-hike cycles. The much lower duration of leveraged loans owing to their floating-coupon payment structure protected the asset class from adverse impact because of rate hikes.
High-yield bonds outperformed leveraged loans during rate-cut cycles due to their greater sensitivity to interest-rate movements, allowing them to benefit more significantly from declining interest rates.
Leveraged loans and high-yield bonds offer attractive yields compared to Treasuries and investment-grade bonds, reflecting their higher credit risk. These asset classes serve as valuable tools for portfolio diversification, enhancing risk-adjusted returns. Historical performance analysis highlights that leveraged loans exhibit lower correlation to equities than high-yield bonds, making them a superior diversifier. Using Markowitz efficient portfolio theory, studies across multiple time frames show that leveraged loans contribute to more resilient portfolios with improved risk-adjusted returns. Additionally, their floating-rate structure reduces sensitivity to interest rate fluctuations. During rate-hike cycles, leveraged loans have historically outperformed high-yield bonds, while high-yield bonds tend to deliver stronger returns in rate-cut environments. By strategically incorporating both asset classes, investors can optimize portfolio performance across different market conditions.
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