Beneath the surface: market structure considerations for syndicated loans
Assumptions in syndicated loan indexes on reinvestment timing, liquidity, and cash drag can distort returns - key insights to navigate structural inefficiencies.
Executive summary
Executive summary
Investors in the syndicated loan market should understand there are structural complexities (e.g. reinvestment timing, liquidity constraints) with regards to the accurate tracking of performance and characteristics of the asset class and thus index providers may need to use broad index assumptions that result in data that may not fully reflect actual market conditions. This piece outlines the key structural considerations and potential strategies that may help manage these challenges and optimize investment approaches.
Market structure considerations
Market structure considerations
Key takeaway
Assumptions made by syndicated loan index providers have resulted in overstated returns and do not fully account for reinvestment timing, liquidity constraints, and cash drag, among other assumptions. Investors should evaluate these structural inefficiencies to optimize portfolio performance.
Understanding market structure challenges:
- What is the base rate paid on a loan?
- When do investors begin receiving coupons on new loans that are added to the index?
- How do investors rebalance after repayments?
- How can an investor reduce cash drag in an asset class that assumes immediate reinvestment but delays coupon receipts?
- Which loans qualify as syndicated and available to investors looking to achieve liquid loan market returns?
Investor challenge
Investor challenge
Certain assumptions behind syndicated loan indexes do not accurately reflect market practice, leading to inflated return expectations.
Unfortunately for investors, we believe that those assumptions often overstate returns. Some of these impacts have become more exaggerated in recent periods, and therefore this is as good a time as ever to review some of those factors. It is also an opportunity for investors to (re)consider optimal structures for interacting with the syndicated loan market. The private credit market has done a reasonably good job in matching fund structure to fund assets. It is time the syndicated loan market did the same, while maintaining materially better liquidity.
Below, we share an overview of some of the issues. More importantly, though, we share some potential solutions that we hope may provide investors with a blueprint to better compete with a loan index, and to possibly capture higher return potential than one would otherwise without necessarily assuming higher risk. As always, we are happy to discuss these themes and opportunities in more detail.
Less Liquid Loans
Less Liquid Loans
Did you know?
The UBS S&P Leveraged Loan Index now contains ~9% non-rated assets, many of which were placed directly with private debt lenders.
Private credit loans continue to shape the market, with the UBS S&P Leveraged Loan Index now containing ~9% non-rated assets, many of which were placed directly with private debt lenders. One can certainly debate whether those private loans merit inclusion in a syndicated loan benchmark. While most would argue against their inclusion, we recognize that the convergence theme is real and many of these issuers have lived and breathed in both markets. Still, what is not debatable is that most syndicated loan investors who cannot originate loans directly because of a myriad of reasons (lack of suitability for underlying investors who expect more trading and rebalancing liquidity, lack of syndication bank involvement, tax issues that limit loan origination yields, lack of ratings flexibility to buy a significant amount of non-rated loans, and more) are not achieving those index returns.
Even if they could, predicting which (and how many) private loans will be included in the index for comparability purposes is another challenge. According to our estimates, the non-rated loan segment inflated 2024 UBS S&P Leveraged Loan Index returns by ~12 basis points as compared to returns for rated loans. And that was during a period where private credit loan exposure increased through the year (and averaged ~5%); if we applied today's ~9% index exposures to last year's returns, the non-rated/private excess contribution on the UBS S&P Leveraged Loan index would be closer to ~20 basis points.
In our analysis, many of these loans are to companies that have previously borrowed in the syndicated loan market and have loan identifiers, but were not syndicated in the traditional sense and do not trade.
For some investors, this information will hopefully be helpful in better understanding what is driving some of the elevated index results. For others, subject to an understanding regarding liquidity and rebalancing, investors may consider selectively incorporating private or simply less liquid credit exposures to better align with the evolving index structure. Even so, given the lower level of transparency on these loans we do worry if the assumed coupons and price activity in the index returns are as accurate as it could be.
Potential impact:
• Approximately 10-20 basis points of return distortion.
Potential solution:
• Inclusion of less liquid/private credit loans into portfolios, if suitable.
Loan Repayments
Loan Repayments
Market data
The unscheduled paydown rate in 2024 was approximately 26%, compared to 13% in 2022 and 19% in 2023. The 20-year average repayment rate is 29%.
As noted above, the unscheduled paydown rate in 2024 was approximately 26% according to JP Morgan, after lower levels in 2022 and 2023 (13% and 19%, respectively). Still, 2024 was more of a normalization than an outlier; the 20-year average repayment rate is 29%. Like all indexes, rebalancing events assume a reinvestment into all other index constituents. In many other asset classes (e.g. equities or investment grade bonds) with high liquidity and T+1 settlement, the assumption is reasonable. In the loan market, there are three critical considerations in our view:
- Syndicated loans are most often traded, but liquidity is not limitless. Reinvestment may cost ~0.25% at the upper end of a typical bid/ask market.
- It may take several days or more to acquire replacement loans.
- Investors do not start receiving coupons until at least T+7 from the trade date (roughly 10 calendar days) upon a secondary purchase.
If the replacement asset for a repaid loan is acquired within a week and settles at T+7 business days, that would entail ~5% of missed coupon (hopefully a manager will be able to keep that capital in money markets as a base rate replacement, and will only miss out on ~5% of the spread). ~5% of index spread in 2024 would have been just shy of ~20 basis points.
Include a bid/ask purchase spread, and repayment activity alone can cost ~40-45 basis points on ~30% of a given portfolio in a typical year. That is equivalent to approximately 10-15 basis points of lost spread that an index is not forced to consider.
It may be worthwhile for investors to consider negative trade-date portfolio cash (allowing a manager to purchase, yet not settle, loans slightly ahead of expected loan repayments) to shorten this impact and reduce cash drag. Investors can also consider funding lines to purchase and settle loans ahead of expected or likely loan repayments in the portfolio. We would note that a leverage or funding line provider would typically require some amount of the facility to be drawn at all times, adding ongoing leverage to the portfolio of loans.
Potential impact:
• Approximately 10-15 basis points of lost spread annually.
Potential solutions:
• Negative trade-date portfolio cash allowance to shorten impact.
• Leverage/funding lines to purchase and settle loans ahead of repayments.
Primary Loan Issuance
Primary Loan Issuance
Market context
2024 saw ~USD 170 billion in net new loan issuance, significantly below 2021’s ~USD 400 billion
As noted above, there was ~USD 170 billion of net new issuance in 2024 according to JP Morgan, which was below certain prior periods (for example, 2021 posted ~USD 400 billion of net new issuance). In a given year, 10-25% of the market may be comprised of in-year new primary issuance. The popular loan indexes will often either assume a loan is paying full coupon at trade allocation (which is not in-line with investors experience) or will include the loan only after its funding (even though investors must buy the non-coupon paying loan at a significantly earlier issuance date to achieve exposure).
Potential impact:
• Approximately 10-25 basis points annually.
Potential solutions:
• Use of funding lines to mitigate funding delays.
As the line between syndicated and private loan markets blur, features (or bugs) of each market converge as well; one of these features is a greater inclusion of delayed draw term loans (DDTLs) and more limited ticking fees from allocation to funding of new loans (private debt lenders often do not charge such fees). And as periods of volatility remain fresh in issuers' minds, companies are more comfortable placing loans as early as possible, further exacerbating this impact. Key considerations:
- Primary term loans can take months or quarters to fund after the trade allocation if their use of capital is subject to deal-related milestones. Even refinancing loans can take weeks to fund.
- Even upon full funding of the term loan, syndicated market investors only start receiving coupon at T+10 business days (~2 weeks) after funding (and not in every case).
- Many new issue loans comprise a portion of delayed draw term loans (a typical new loan may have >10% allocated to a delayed draw). These loans typically do not pay full spread, and sometimes only a modest ticking fee for periods up to two years, in some cases.
While data on these impacts are limited, one can estimate that ~2 months of funding impact (missed coupon) for true new issue loans on 10-30% of the market would mean 5-20 basis points of inflated index coupon in a given year. When including additional impacts from refinancing loans (where several weeks of lost coupon can occur to simply process repayments and fund the new loans) and delayed draw loans (where a portion of loans do not receive coupons for an extended period of time), that estimate could be closer to a 10-25 basis point impact. Like the redeployment impact, a strategy that comprises the fund structure arbitrage employed by private debt funds (trade debt cash flexibility, leverage and funding lines) could be highly impactful in correcting some of the assumptions embedded in index returns.
Potential Impact:
• approximately10-25 basis points
Potential Solutions:
• leverage/funding lines
In Summary
In Summary
The forward rate outlook, spread environment, and constrained market issuance from 2022 to 2024 suggest that while index returns in 2025 may be lower than those in 2024, the gap may not be as pronounced as in previous market cycles. Still, while loans are often viewed as a stable-returning asset class (the UBS S&P Leveraged Loan Index has recorded only three negative years since its inception in 1992), the last time loan returns remained within 200 basis points of the prior year was 2005-2006.
Exogenous macroeconomic events frequently impact loan performance, and calendar year returns can be skewed by timing effects surrounding cut-off dates.
Final thought
Final thought
“Like a duck on water, the syndicated loan market appears calm, but significant forces shape its movement beneath the surface.” Market forces, both supportive and challenging, will continue to propel and shape outcomes this year.
Connect with us to explore strategies for navigating structural inefficiencies in the syndicated loan market.
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