Oppenheimer Turns to Leveraged Loans to Hedge Fed, Trump RisksBy
‘Probably going to be best performing asset class this year’
Global Strategic Income Fund has an unprecedented 12% in loans
Oppenheimer Funds Inc. is loading up on loans like never before in an effort to soften the potential blows from future interest rate hikes by the Federal Reserve and the Trump administration’s fiscal stimulus plans.
Leveraged loans appeal to investment firms like Oppenheimer because of their ability to generate income while erasing rate risk. Since the November election, the $200 billion asset manager has bought as many corporate bank loans as possible, including boosting the allocation in its flagship Global Strategic Income Fund to an unprecedented 12 percent, chief investment officer Krishna Memani said.
“Loans are probably going to be best performing asset class this year, perhaps by a wide margin,” Memani said by phone from his office in lower Manhattan, adding that he expects the sector to return around five percent this year. “Wherever we have the flexibility to do so, we have allocated into loans.”
The debt gained 10.9 percent in 2016, after losing close to 3 percent the year before, according to the S&P/LSTA US Leveraged Loan 100 Index.
Loans have coupons that float on a variable rate like Libor, which resets each month and generally keeps pace with the interest rates controlled by the Federal Reserve. The securities also carry less credit risk than bonds because they’re senior in a company’s capital structure. This is part of what appeals to Memani, who believes markets are underestimating the financial risks of the Trump era.
“More contradictions are manifesting themselves every day in terms of what the policy objectives are,” Memani said. “The risks are rising.”
As an example of the confusion, Memani pointed to Trump’s much-touted fiscal spending plans and how they contrast with the hawkishness of his nominee for budget chief, Representative Mick Mulvaney, who says he wants to rein in deficits. The prospect of increased infrastructure expenditures helped inspire the so-called “animal spirits” that have buoyed risk assets since election day. Junk bond spreads narrowed and the Dow Jones Industrial Average reached fresh highs before Trump even took office.
However, it’s foolhardy to trade on assumptions regarding future policy, Memani said, especially when it comes to an administration that’s still “all over the place” in its messaging.
“Markets at the moment are more about hope than reality,” he said, “and it’s too early to say what the reality will be.”
Much of what Memani appreciates about loans comes down to duration, the measure of an asset’s price sensitivity to changes in interest rates. In that regard, loans benefit not just from their floating coupons but also their short maturities. The average life of a corporate bank loan is usually around three years due to issuers’ use of call options. But it has shortened further recently as companies embark on repricing sprees, demanding that creditors accept cuts in their coupon payments or lose the loan entirely.
Memani acknowledges the repricing risk in loans, but contends it’s minor compared to how much value bonds can lose as interest rates climb. Loans may have limited upside, but to Memani their limited downside is what matters most this year. That’s his trade-off.
“Expecting a significant amount of price appreciation from loans is unrealistic, because if prices appreciate too much the issuer refinances and takes it away,” he said. But “that outcome is better than having the prices of your holdings go down because of an interest rate increase.’’