Junk Loans Shine Amid Market Rout

The $1.3 trillion market for leveraged loans gained 0.66% this year through Friday, while tech stocks lost as much as 12% and typically safe debt such as municipal bonds and Treasurys also fell.

“It’s the one asset class in fixed income that tends to go up in value when rates rise,” said David Giroux, manager of T. Rowe Price’s $51 billion capital appreciation fund, which buys a mix of equity and debt. 

Mr. Giroux has boosted loan investments to 12% of assets from 1% three years ago, providing a partial buffer against falling share prices. The fund lost about 5% in the first three weeks of the year, according to Morningstar.

Expectations that the Federal Reserve will raise rates have recently hit speculative investments such as cryptocurrencies and meme stocks that reached lofty valuations last year. The selling intensified early Monday when the S&P 500 dipped into correction territory before rebounding later in the session.

Companies that borrow leveraged loans pay floating interest rates, which rise when the Fed tightens monetary policy. Interest payments on most bonds are fixed, causing their prices to fall when prevailing rates climb. Stocks also can suffer because that pushes corporate borrowing costs up, potentially damping growth.

Leveraged loans have low credit ratings because the companies that borrow them carry high debt loads—often to pay for private-equity buyouts. Still, default rates are near record lows and most investors are far more concerned about rising interest rates.

“I think 2022 will be a very healthy year,” said George Goudelias, manager of the $2.5 billion Virtus Seix Floating Rate High Income Fund, which specializes in the loans. Inflow cycles typically last two years when rates are rising and investors only started putting cash back into loan mutual funds in early 2021, he said.

The flood of money is affecting how companies choose to raise new capital. Casino operator Golden Nugget LLC increased the size of a loan it issued this month to $3.45 billion from $1.85 billion amid strong investor demand, according to S&P Global Market Intelligence. The new money refinanced existing debt and paid for a $250 million dividend to shareholders.

Existing loan prices also are rising at a faster pace than anticipated.  

“It was not our expectation that the first month of the year would pull forward so much of the annual return,” said Michael Anderson, a strategist at Citigroup Inc. who is forecasting a 3% return from leveraged loans for all of 2022. Prices are unlikely to rise much further but the interest they pay will move with Fed policy, he said.

The largest risk for loan investors now is that rates peak, then stall or drop more quickly than anticipated, Mr. Anderson said. “This is a compressed cycle and things are happening faster than they did in the past.”

Write to Matt Wirz at [email protected]