Is The Market Still In The Right Place For Senior Loans To Outperform?

A Look At Non-Traditional High Yield Options

Every week, we’ll profile a high yield investment fund that typically offers an annualized distribution of 6-10% or more. With the S&P 500 yielding less than 2%, many investors find it difficult to achieve the portfolio income necessary to meet their needs and goals. This report is designed to help address those concerns.

Now that interest rates have risen considerably over the past couple of years, the opportunities for income seekers have grown as well. Where cash was trash for years, investors can now capture risk-free 5% yields from Treasury bills. For many, that’s eliminated the need to wander further out on the risk spectrum for additional yield. For others, however, this evolution in the fixed income market has simply made existing high yields even higher. Broad-based junk bond portfolios and emerging markets bonds offer 8-9% yields, while other corners of the market allow investors to capture double digit yields. But the macro environment is deteriorating and a credit event may be looming. That means investors reaching for high yields need to be mindful of the risks they’re taking to get them.

Which brings me to the BlackRock Debt Strategies Fund (DSU). It consists mostly of senior loans, which can be a nice middle ground for high yield seekers. They’re considered “senior” because they sit higher on the issuer’s capital structure, but are typically less volatile than traditional high yield corporate bonds. While they won’t provide a whole lot of downside protection should the bond market go sideways, they could be an interesting way to add a high yield to your portfolio and diversify away some fixed income risk.

Fund Background

DSU's primary objective is to provide current income by investing primarily in a diversified portfolio of U.S. issued debt instruments, including corporate loans that usually fall in the lower rating tier, typically considered BBB and lower. Corporate loans include senior and subordinated corporate loans, both secured and unsecured. DSU also utilizes leverage in order to enhance yield and total return potential.

The proceeds of senior loans are typically used to fund normal company operations, so the lower credit profile of these securities strongly suggests that the companies issuing them are experiencing at least some degree of financial trouble. In many cases, companies turn to senior (or leveraged) loans because they can’t find acceptable terms or liquidity in the traditional credit markets. On the plus side, most of these senior loans are floating rate, meaning that they have very limited exposure to the gyrations of the yield curve. That may have helped fund performance when rates were soaring, but could also cause it to lag if rates start falling again. The fact that composition of this fund is already fairly poor quality is a concern, but the addition of leverage on top of the portfolio means investors should be careful when adding it to their portfolio.