2023 was marked by incidents such as rampant inflation, the collapse of major financial institutions, geopolitical conflicts, polarised politics, and a US sovereign debt ceiling debacle. M&G Investments points out that amidst these challenges, European leveraged loans generated healthy double-digit returns.
“This performance can be attributed to the defensive composition of the loan universe, its floating rate structure and no direct exposure to banks or conflict regions,” says the asset manager.
“Furthermore, borrowers have largely attended to their debt maturities, bolstering defences for the foreseeable future and mitigating default risk,” it adds.
As per M&G, factors contributing to this defensiveness include subdued new loan issuance driven by M&A challenges, active refinancing, and a reduction in the near-term maturity wall for European loans. Additionally, the asset manager contends that despite lower supply, demand remains robust, supported by collateralised loan obligations and other investors seeking defensive assets.
While elevated rates pose challenges for sub-investment grade companies, rating agencies have revised downward forecasts for European loan defaults in 2023, informs M&G. According to it, the maturity wall, distressed credits, and companies with low cash flow are identified as potential contributors to future defaults, expected to peak in 2024.
Furthermore, the asset manager suggests that European leveraged loans offer an attractive risk/reward profile for investors in 2024. Also, M&G asserts that the stability of return streams from loans, driven by income rather than capital gains, adds to their appeal.
“European loans have proven their worth as a strategic and tactical allocation in 2023 and could do the same in 2024. With potential all-in yields of 8-9% (in euro terms) and discounted entry points in the mid-90s, investors have not missed the opportunity,” says the asset manager.
“…we believe that real yields, achieved sustainably through robust credit selection, hold value for investors during periods of volatility in the broader public markets,” concludes M&G.
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