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While browsing Yahoo Finance this week, a particular article caught my eye, “Regulators Alarmed by Risky Loans, But Don’t Know Who Holds Them.”
The risky loans these regulators are worried about are called leveraged loans, and prominent voices in finance and economics have been echoing a similar sentiment for the past several years.
Bonds and loans are essentially the same. We as investors can loan our money to a government, bank, or corporation for a period of time, receive a fixed interest rate, and our money back at the end of the term. US government bonds are considered risk free while corporations are given a credit rating based on their financials, just like all of us.
A leveraged loan is a type of loan taken by a company with a low credit rating. If the economy experiences a rough patch, loan defaults could rise, causing losses for their investors. For context, an Oppenheimer mutual fund that invested in risky bonds and loans declined 82% during the 2007-09 financial crisis.
Why then are investors putting their money into these risky loans?
Simply put, investors are “reaching for yield.” Frustrated with only a 2% return on a US government bond, investors are taking on additional risk for higher returns. This “reaching for yield” helped fuel the subprime mortgage crisis that led to the 2007-09 financial crisis.
Quality is really important within investment portfolios, and bonds are meant to be vehicles of capital preservation while providing income and liquidity to investors. Boring yes, but essential to a diversified portfolio, especially for a retiree taking income.
There are no leveraged loans in any Kane Financial managed portfolios. I truly believe bonds should be bonds, and any risk in a portfolio should come from owning shares of a company.
If you have outside investments and you are not sure about the credit quality of the bonds and loans in the portfolio, please contact the office as I’d be glad to review this for you. Investments titled “High Yield, Junk, or Senior Loan” are considered higher risk investments.
Have a great week and please don’t hesitate to contact the office with questions!