Monday, January 2, 2012

HY bonds outperform leveraged loans

High yield bonds outperformed leveraged loans by almost 4% (HY: 5.5%, LL: 1.8%) in 2011 based on the Credit Suisse Leveraged Finance indices.

However, this comparison doesn't tell the whole story. Because leveraged loans are floating rate instruments based on LIBOR, while HY bonds have fixed coupon, the difference in performance has mostly been due to interest differential. If one compares principal-only returns, both asset classes are down about 2.5% for the year.  This has been a year in which interest/dividends make all the difference in performance.

There is however another difference in the two asset classes.  The HY bond index had a weekly principal-only volatility of 1.0% in 2011, while the Leveraged Loan index volatility has been 0.6%.  Thus HY bond investors were compensated an extra 4% for taking higher market risk.  HY bond investors also took higher credit risk because bonds tend to be unsecured instruments (though not always), while loans are usually senior secured.

Going forward, both of these asset classes continue to look interesting as the default rates in the US are expected to stay low.
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