The European Central Bank recently announced its stimulus plan that will involve buying $69bn a month in assets, including government bonds, debt securities issued by European institutions and private-sector bonds. With concerns revolving around future spreads, investors are re-evaluating their portfolio strategies going forward, assessing alternative ways of optimizing their risk-return profile. Understanding the effect of the Quantitative Easing (QE) program and market cycle going forward, many institutional investors are split between the short-term and long-term play when seeking fixed income investments.
The majority of the market can agree that in the short term, yields are expected to fall in the European market, and remain low for the foreseeable future. With the fear of weakening market conditions, investors are seeking safe investments, such as government bonds and senior secured assets. In anticipation of the QE program, top asset managers have already begun to act, bringing private loan funds to market targeting the SME space. Preqin’s data shows that in the past year, mega-fund managers, such as GSO Capital Partners and KKR, have introduced senior secured funds targeting the European market.
Historically, in a falling yield environment, senior secured loans have posted impressive risk-adjusted returns in terms of low default rates, low price volatility and low correlation to other asset classes. Given their place in the capital structure, senior secured loans will be one of the safest investments given the historically high recovery rates.
Investors seeking a more long-term strategy may find senior secured loans attractive for other reasons. With the floating interest rate component, loans can actually benefit from increases in interest rates, as opposed to traditional high-yield bonds, given their well-protected cash flows with a built in hedge against rising interest rates and inflation. Given the nature of the investment, regardless of the strategy, Europe should remain attractive for years to come for investors targeting direct lending vehicles in the private debt space.