1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Holly LaFon
Holly LaFon
Articles (8057) 

Hotchkis & Wiley Q1 Newsletter - The Interest Rate Environment: Comparing High Yield Bonds and Bank Loans

April 16, 2013 | About:

Introduction: It has been over four years since the Federal Open Market Committee ("FOMC") voted to lower the overnight rate at which banks lend to each other ("fed funds rate") to a range of 0.00% - 0.25%. The FOMC has maintained this target ever since and Treasury rates of all maturities have persisted near record lows as a consequence. The prevailing environment has prompted many investors, Hotchkis & Wiley included, to question how long it will be before interest rates rise once again.

Based on discussions with economists, strategists, and other industry experts, the consensus view appears to be an inevitable rise in interest rates but with highly uncertain timing. In its most recent meeting minutes, the FOMC stated that it will keep the target fed funds rate at the current level until employment improves, inflation remains in check, and "other" market conditions comply. Such an opaque framework is unsettling. The timing and direction of interest rate movements, while nearly impossible to forecast precisely, has material implications for investment returns. Interest rate changes can affect equity markets but influence fixed income markets disproportionately— particularly when the change is unexpected. We recognize that there is a risk of rising rates, but given the headwinds facing the economy, we also understand that rates could persist at low levels for an extended period. Because our outlook for interest rates is rather ambiguous, we will contrast two credit instruments in a variety of interest rate environments: high yield bonds and bank loans. Our goal is to ascertain whether one, the other, or both are appealing investments in today's environment.

The first step in our exercise will be to contrast the high yield bond market and the bank loan market. It will reprise the main conclusions drawn from the 2011 2Q Newsletter, "A Synopsis of the Bank Loan Market" (which we are happy to resend if requested). Once we have summarized the two asset classes, we will evaluate historical, current, and potential interest rate environments. Finally, we will analyze the behavior of the high yield market and the bank loan market in these different interest rate environments to determine whether we can make any sensible conjectures about the future.

Quick Review: High Yield Bonds vs. Bank Loans

High yield bonds and bank loans are undeniably nuanced, but both are generally classified within the same realm: high yielding credit instruments. Because both asset classes exhibit greater default risk than investment grade bonds, investors demand higher yields. Because both asset classes are senior to equity in the corporate capital structure, they exhibit lower volatility than stocks. For investors seeking greater yields than those offered by investment grade bonds but who are unable or unwilling to tolerate the volatility of equities, both high yield bonds and bank loans may appear interesting.

Continue reading here.

Rating: 5.0/5 (1 vote)


Please leave your comment:

Performances of the stocks mentioned by Holly LaFon

User Generated Screeners

averacjrnot about to fail
ligeron.4gJoel Greenblatt
liuzishuNon-Div Beneish EV/EBITDA
liuzishuNon-Div Beneish ROA/E
alberto.lopezblancoMomentum / Deep Value_V2
alberto.lopezblancoMomentum / Deep Value_volume
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)

GF Chat