The Case for Investing in Senior Secured Bonds
From capital structure seniority and high historical recovery rates, to lower interest rate sensitivity and compelling yields, global senior secured bonds offer a number of potential advantages.
Why Senior Secured Bonds?
The global senior secured bond market is a sizable sub-component of the broader global high yield bond asset class and, as the name indicates, comprises bonds that are senior and secured in the capital structure. Senior secured bonds reside at the top of a company’s capital structure, ranking first in line for repayment in priority over other liabilities and shareholder interests. They also benefit from security interests in various firm assets, which can include tangible assets—such as property, plant and equipment, inventory and contractual claims—as well as intangible items like software and trademarks. Ultimately, this means that if a company defaults on its debt obligations, senior secured bondholders are first in line for any repayments, in priority over other creditors, and also stand to benefit from their control (via the security interests) in the assets that are critical for running the business.
As a result, senior secured bonds have historically offered higher recovery rates than unsecured bonds. For example, from 1987 to 2021, the average recovery rate for defaulted senior secured bonds was 61.5%, compared to 47.4% for senior unsecured bonds and 27.9% for subordinated debt.1 The success of the senior secured bond market has been such that over the past five years it has increased in size by roughly 70% to over $500 billion, equivalent to about one third of the global high yield bond market.2 This is a broad, deep and well-diversified market that provides ample options for an active global high yield manager, with a rich opportunity set to generate sustainable alpha.
Why Now?
Navigating a Challenging Environment
It has been an extremely challenging and volatile period for most financial markets this year, driven by elevated inflationary pressures, hawkish central bank activity with expectations of rising interest rates and tightening financial conditions, geopolitical tensions with Russia’s invasion of Ukraine, and the ongoing disruption from COVID-19, particularly in key regions such as China. Like other segments of the global fixed income markets, senior secured bonds have not been immune from the pressure stemming from the rise in government bond yields around the world.
Of note, however, senior secured bonds have outperformed most other global bond markets year to date. This is largely due to the asset class’ shorter duration profile (a measure of interest rate sensitivity) and high coupon levels, which have created an attractive alternative to the higher-quality, more interest rate sensitive segments of fixed income.
1. Source: Moody’s Investors Services Annual Default Study. As of February 8, 2022.
2. Source: ICE BofA BB-B Global High Yield Secured Bond Index, ICE BofA Non-Financial Developed Markets High Yield Constrained Index. As of April 30, 2022.
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