In September 2005, ING Investment Management launched ING International (II) – Senior Bank Loans Euro, a Luxembourg-based, euro-denominated Sicav that invests primarily in senior bank loans. This fund gives European investors access to this asset class, with daily market values and attractive liquidity options. In this article, the characteristics of this asset class, the investment opportunities and the expertise of ING Investment Management will be discussed.
Senior bank loans: the asset class
Senior bank loans are loans made to non-investment grade companies primarily to finance acquisitions, refinance existing debt, support organic growth, or pay out dividends. Senior bank loans are originated by large, money centre banks and are then syndicated out to institutional investors (collateralised loan obligations (CLOs), mutual funds, hedge funds, insurance companies, pension funds, etc.) as well as to other banks. The size of these loans can vary from €50m to well over €3bn.
The senior bank loan market historically had been dominated by commercial banks. However, as bank regulatory capital requirements for loans increased, and commitment and underwriting fees were pushed down by increased competition, institutional investors have entered the market on a large scale. In the US, this development started in the early-1990s, while in Europe it has begun much more recently. Today, commercial banks are using their loan operations to earn fees and to bring in additional sources of revenue (cash management services, M&A advisory work, etc.).
Figure one shows the primary issuance volumes and size of the asset class in the past 17 years for the US. The senior bank loan market has grown significantly since 1989, and it continues to grow both in the US and Europe. Currently, the total size of the US senior bank loan market is roughly $1200bn (€928.2bn), while the European market is roughly €280bn. In the US, institutional investors comprise almost 75 per cent of the investors in this asset class, while traditional banks make up only 25 per cent. In Europe, institutional investors comprise 40 per cent of the investors in this asset class, vs. 60 per cent for banks, although this is changing in favour of the institutional investors in Europe.
Senior bank loans: characteristics
Senior bank loans are senior secured floating rate debt instruments. In a borrower’s capital structure, they are typically senior to all other debt and they are secured by the assets of the company.
An important aspect of senior bank loans is that they are floating rate, not fixed rate. Senior bank loans pay interest at rates that represent a fixed spread (typically 150 basis points or more, depending upon the credit quality of the loan) over the London Inter-Bank Offered Rate (Libor), and these rates reset periodically, usually monthly or quarterly. As a result, senior bank loans have an ultra-short interest rate duration, making them a natural hedge against fluctuations in short-term interest rates. Because their interest rates float, senior bank loans always pay at market rates, so the underlying principal value of a senior bank loan is relatively insensitive to changes in short-term rates.
Another important aspect of senior bank loans is that they are secured by the assets of the borrower. In default situations, senior bank loans historically recover significantly more than unsecured high yield bonds.
The floating rate nature of senior bank loans, combined with their senior secured position in a borrower’s capital structure, produce a very low volatility profile.
In addition, senior bank loans historically have produced positive returns, even in the turbulent years of 1998 and 2001/2002. Senior bank loans, unlike high yield bonds, have never experienced a negative return year.
Lastly, senior bank loans exhibit very low correlation to other asset classes. Figure two shows the correlation to several common investment categories.
Senior bank loans: institutional investors
For institutional investors, diversification is an important method to enhance performance relative to risk. Institutional investors are investing in senior bank loans because of their unique risk/return characteristics (low volatility vs. relative high returns amongst others) and diversification (low correlation vs. other asset classes). This distinctive pattern of returns produces low correlation benefits with respect to most other asset classes, making a position in senior bank loans particularly valuable in terms of its potential contribution to the diversification of institutional portfolios.
Senior bank loans: ING Investment Management
ING Investment Management has its own senior bank loan strategy. The ING Senior Debt Group, located in Scottsdale, Arizona (US), has been active since the mid-1990s in the US senior bank loan market. This team continues to be one of the major players in the US with an excellent track record, offering a conservative “through the cycle” strategy to its institutional and retail client base. The group has expanded into the European senior bank loan market with an investment team in The Hague, the Netherlands.
The team consists of 19 investment professionals and 14 dedicated support staff. Assets under management are currently over $7bn, divided into US funds, European funds and CLOs. The ING Senior Debt Composite has industry leading alpha ratios and sharp ratios and significantly lower default rates than the benchmark S&P/LSTA index. As shown in figure three, their strategy has also produced returns that have consistently out-performed the benchmark on a gross returns basis.
The ING Senior Debt Group believes that senior bank loans provide high risk-adjusted total return with relative low volatility. Within the senior bank loans asset class, a security selection approach focused on top tier quality non-investment grade loans (B to BB+) implemented by experienced credit analysts within a disciplined research and risk management framework can produce superior long-term, risk-adjusted performance. Since credit risk is the primary risk to a portfolio of senior bank loans, the portfolio management teams of sector specialists combine fundamental credit analysis with extreme diversification and an emphasis on highly liquid loans to construct the portfolios.
The developments in the European loan market have triggered interest from European institutional investors, and have created opportunities for further diversification within the ING Senior Debt Strategy. This has lead to the establishment of ING International (II) – Senior Bank Loans Euro, a Euro-denominated senior bank loan fund, in September 2005 and the establishment of the ING Senior Debt Team Europe in early 2006.
The ING Senior Bank Loans Euro fund offers daily marked-to-market net asset values and twice monthly redemption opportunities. The fund has performed well, out-performing the benchmark S&P/LSTA Leveraged Loan Index (as hedged to the euro) on a gross returns basis since inception. The fund has also attracted significant intuitional investor attention, growing to roughly €1bn in assets in less than a year. The fund is managed by the ING Senior Debt Group in accordance with their existing strategy. This fund invests in US dollar and non-US dollar denominated loans and US and European domiciled companies offering a well diversified asset base. All currencies will be hedged to euro.
The ING Senior Debt Team Europe is benefiting on one hand from the strong name ING Investment Management Europe has in the European financial markets, and on the other hand from the excellent track record, experience and know-how of the ING Senior Debt Group in Scottsdale. By way of personnel exchange programmes, knowledge is transferred between the two teams. The European team is fully integrated in the ING Senior Debt Group and operates with the same tight risk controls, operational platforms and decision-making process (using one investment committee) as the US based team.
The ING Senior Debt Group is a flexible team capable of fulfilling the specific needs and requirements of the individual clients, ranging from leveraged and non-leveraged products making use of the capabilities of the whole ING organisation. Based on the low correlation, excellent risk/returns characteristics and low volatility an investment in senior loans enhances your risk return profile and thereby deserves a place in your portfolio.
ING Investment Management:
ING Investment Management is ING Group’s largest asset manager. We provide a full spectrum of investment solutions and administration services for institutional clients and we manage assets for the ING labels. We are a global asset manager with more than €360bn assets under management. Our three regional organisations (Europe, Americas and Asia Pacific) guarantee a detailed knowledge of local clients and local markets, while our global investment engine provides global investment opportunities. We have offices and investment professionals in more than 30 countries across the world, giving the organisation a global reach while maintaining a local focus.
