Don’t Bank on Bank Loans in 2023

As bond yields rose in 2022, investors sought refuge in high-yield bank loans, whose floating coupons are often heralded as an antidote to rising rates. But with conditions shaping up differently in 2023, bank loans may face challenges. We think income-seeking investors should instead consider a more diversified approach that balances rate and credit risks. Here’s why.

Bank Loans Are Vulnerable When the Credit Cycle Turns

Floating-rate bank loans tend to do well when conditions are just right: the Federal Reserve is raising rates and the economy is growing. But such conditions typically don’t last long. In fact, we think the tide may soon turn: the banking crisis is tightening financial conditions, the Fed’s May rate hike may be its last, and US GDP growth is poised to slow in the second half of the year.

Exposure to bank loans at this late stage of the credit cycle is risky. Bank loans have historically underperformed during economic downturns (Display).