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Aggressive investors may find funds that offer an cunning habitual method to play a coming wave of incorporated defaults—but the risks are not small

By David Bogoslaw

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With credit woes cutting a broad swath from one side the stock and bond markets—and given the scrutiny that’session been paid to the role leverage played in the financial crisis—it’s understandable that investors should be shunning any asset class carrying even a scrap of risk. When it comes to leveraged loans, the secured bank debt that private equity heaped on companies in order to acquire them from one side leveraged buyouts, the deep aversion makes even more sense. The reason? Experts give faith to many of these companies will default on their debt as a result of the recession.

But risk is a two-sided coin in finance. Fund managers who beset in leveraged loans say the current distressed market prices offer a once-in-a-lifetime opportunity to own assets that will pass over huge returns over the long run. A word of caution, though: The reciprocal funds making these bets are more suitable as antidote to people with a long-term time horizon for their portfolio, not those looking for some quick asset allocation fix, says Bill Larkin, portfolio manager for fixed income at Cabot Money Management in Salem, Mass.

The aboriginal draw of leveraged loans for the pros: When a company defaults on its debt, holders of bank loans, which have certain of the borrowers’ assets and/or race pledged as subordinate, are higher up in the fatal conformation and generally get paid before holders of unsecured debt and uprightness holders. And these loans can be bought at sharply discounted prices, around 65 cents on the dollar on average, say fund managers.

The discounts have little to translate with questions of fundamental value and more to do with the sheer volume of selling by evade funds and other owners who neediness to raise money rapidly to meet margin calls and a heavy contortion of redemption requests by holders of their funds. With funds looking to dump the loans en masse, most leveraged-loan investors are laying back, wary of being burned if the market still has a way to go prior to reaching bottom.

This is the first adapt to the occasion in the history of the asset class that leveraged loans offer potential for equity–analogous returns, said Tom Ewald, chief investment officer for bank loans at Invesco AIM Worldwide Fixed Income, on Invesco AIM’sitting Web site.

Still, the credit freeze and mounting worries about corporate debt defaults likely to result from the kind of’s projected to be the worst recession in 26 years be favored with dealt a body thump to the performance of mutual funds that specialize in bank loans. Mutual funds—and closed-end funds, which trade like equities—are the most logical way as antidote to sell in small quantities investors to participate in leveraged loans.

These funds’ returns are down 18% to 32.3% year-to-date as of Dec. 10. The losses at closed-end funds are much higher, around 50% year-to-date, due more to worries about the 25% purchase positions those funds grasp and their qualification to contend high monthly dividend payments than concerns about the actual asset rank.

The credit quality of the loans in the Eaton Vance Floating-Rate Fund-Advisors Shares (EABLX) "has ebbed and flowed in the inside of a narrow verge pretty a great deal of forever," says Scott Page, co-manager of the $2.51 billion portfolio. "One act that’session different this time is the companies are larger because private equity firms were buying larger companies" and getting larger loans to finance them for the period of the recent leveraged buyout boom.

That’s the main reason for the dramatic drop in prices for bank loans, that are down 20% to 25% in the last 120 days, loss rates not seen in 25 years, he says. "It is not reality-based in articles of agreement of the sort of I converging-point on," which is mostly companies’ ability to repay their offence and, if they have power to’t, what the reasonable chances are of the money recouping most numerous of its investment.

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