Must-know: The difference between high-yield and leveraged loans
<p>Historically, high-yield securities have outperformed investment grade securities in good times and vice versa in hard times.</p>
High-yield bonds refer to below investment grade (BB+ and below) corporate bonds because they pay a higher yield than Treasury (TLT) and investment grade corporate bonds (LQD) as an additional credit risk premium. Historically, high-yield securities have outperformed investment grade securities in good times and vice versa in hard times. When times are good, even the issuers with a low credit quality benefit from the economic scenario. However, when the times are hard, they are the first ones to get hit.
Leveraged loans refer to syndicated loans given to already leveraged issuers. On the surface, leveraged loans look similar to high-yield bonds, but both these asset classes differ significantly as seen in the following table.
Leveraged loans have limited interest rate risk because they have a floating rate feature. As a result, leveraged loans are protected from the rising yields on treasury securities. The Fed has taken a peaceful stance in its recent meetings meaning that the interest rates may stay low until the labor market conditions improve considerably. The stance has ensured smooth sailing for high-yield ETFs such as the iShares iBoxx $ High Yield Corporate Bond Fund (HYG) and the SPDR Barclays Capital High Yield Bond ETF (JNK). HYG and JNK have given year-to-date returns of 3.07% and 3.44%, respectively. Performance of the PowerShares Senior Loan Portfolio Fund (BKLN), an ETF investing in leveraged loans, has remained subdued as seen in year-to-date returns of just 0.77%.
To learn more about how the primary market for investment grade bonds performed last week, continue reading the next part of the series.