Most investors have never heard of secured loans, yet they quietly fund some of the world's largest and most familiar companies. These loans sit in a corner of the market that rarely makes headlines, but they play a vital role in corporate finance. For everyday investors, understanding how they work can open the door to a source of income and diversification that behaves differently from stocks and bonds.
What are secured loans?
In simple terms, a secured loan is money lent to a company with added protection for the lender. If the borrower can't repay, the lender has a legal claim over specific assets or collateral—similar to how a house secures a mortgage. This collateral can include property, equipment, inventory, or even intellectual property. Because the loan is backed by something tangible, the lender stands a better chance of recovering their money if things go wrong.
These loans are typically made by banks or institutional investors, but they are also packaged into funds that individual investors can buy. They are often used by companies that need financing but may not have the credit rating to issue traditional bonds. That includes well-known names in retail, technology, and healthcare—companies you likely interact with every day.
How do they generate returns?
Secured loans pay interest, just like bonds. The interest rate is usually floating, meaning it adjusts periodically based on a benchmark like the London Interbank Offered Rate (LIBOR) or the Secured Overnight Financing Rate (SOFR). When central banks raise interest rates, the income from these loans tends to rise as well. That makes them an attractive option in a rising-rate environment, unlike fixed-rate bonds whose prices fall when rates climb.
Because the loans are secured, they typically offer lower interest rates than unsecured debt—but higher than what you'd get from a government bond. The trade-off is that they carry more risk than government securities, but less than unsecured corporate bonds or stocks.
What happens when a borrower runs into trouble?
The key advantage of secured loans is the protection they offer when a borrower faces financial distress. If a company defaults, the lender can seize the collateral and sell it to recover their investment. In a bankruptcy, secured lenders are first in line to be paid, ahead of unsecured bondholders and shareholders. This priority can significantly reduce losses in a downturn.
That doesn't mean secured loans are risk-free. If the collateral loses value or the company's assets are insufficient to cover the debt, lenders can still lose money. But the added layer of security means that, historically, secured loans have experienced lower default losses than unsecured debt.
Why they matter for a diversified portfolio
For everyday investors, secured loans can be a useful addition to a diversified portfolio. They offer income that is often higher than government bonds, and their floating-rate nature provides a hedge against inflation and rising interest rates. They also tend to have low correlation with stocks, meaning they can help smooth out returns when equity markets are volatile.
However, they are not without risks. Credit risk—the chance that a borrower defaults—is always present. Liquidity risk is another factor; some secured loan funds allow daily redemptions, but the underlying loans can be harder to sell quickly. Investors should also be aware of fees, which can eat into returns.
For those interested in adding secured loans to their portfolio, the most common way is through mutual funds or exchange-traded funds (ETFs) that specialise in this asset class. These funds pool money from many investors and spread it across dozens or hundreds of loans, reducing the impact of any single default.
What to watch next
Investors should keep an eye on interest rate trends, as they directly affect the income from secured loans. Central bank policy, such as the Federal Reserve's decisions, will influence how attractive these loans are relative to other income investments. Also watch for signs of stress in the corporate sector—if defaults rise, even secured loans could feel the pinch, though their built-in protection should cushion the blow.
Secured loans may not be as glamorous as the latest tech stock, but they offer a blend of income, diversification, and downside protection that many portfolios lack. For investors looking to build a resilient portfolio, they're worth getting acquainted with.
