With central banks cutting rates in the US and Europe, it is natural for investors to consider what lower rates may mean for certain areas of the credit markets. The recent European Central Bank rate cuts have brought yields down for leveraged loans, which are floating rate in nature. At its peak in late 2023, the Morningstar European Leveraged Loan Index’s yield to maturity surpassed 9%. But according to research from Morningstar Indexes, the asset class benefits from structural growth drivers and is “not so niche anymore.”
As of the second quarter, the market for broadly syndicated bank loans in Europe had more than tripled over the past decade.
In the US, the leveraged loan asset class is now larger than high-yield bonds, while in Europe, the two markets are of similar size. Financing demand from private equity-backed borrowers and buying demand from collateralized loan obligations (CLOs) have helped catalyze growth. While credit risk is endemic to the asset class, the Morningstar European Leveraged Loan Index has registered lower overall volatility than its high-yield bond counterpart. Meanwhile, leveraged loans’ low correlation with equities and government bonds gives them diversification appeal.
Katie Binns, Director of Fixed Income & Multi-Asset, Morningstar Indexes:
“While yields on European leveraged loans have come down, they still exceed levels on high-yield bonds and most other fixed-income instruments. A widening set of credit investors is using this asset class in a short-term tactical manner or for long-term strategic allocations. While credit risk is a feature not a bug of leveraged loans, they have many merits as part of a well-diversified portfolio.”
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