Kyobo Life Insurance Co., South Korea’s third largest, plans to increase investments in U.S. leveraged loans on a bet that yields overstate the risks of corporate default.

“Spreads on mezzanine debt are more attractive than those on senior debt,” said Eugene E.S. Chung, who helps oversee $25 billion as head of investment management at the Seoul-based insurer. Yield spreads don’t reflect the likelihood of the world economy avoiding a double-dip recession, he said in an interview at his office in Seoul.

Kyobo Life plans to add to investments with funds specializing in mezzanine debt, said Chung. Providers of mezzanine financing, which include leveraged loans and high- yield bonds, only get paid after senior creditors if borrowers default, and receive higher returns for embracing more risk.

A team of former Lehman Brothers Holdings Inc. bankers said in May they’re starting a fund called Neovara LLP to buy mezzanine debt. London-based Intermediate Capital Group Plc in April raised 843 million euros ($1.1 billion) for a mezzanine fund. There’s “strong investor recognition” of the virtues of mezzanine, David Wilmot, a managing director at Babson Capital Management LLC, with $118 billion of funds, said in May.

“Global deleveraging helped companies bolster equity capital, reducing default risks,” said Chung. “Mixed views on the global economy stemmed major players from taking risks and the credit spreads from tightening enough.”

Loans vs Bonds

For the week to Aug. 6, the extra spread investors demand to own North American leveraged bank loans fell 4 basis points to 650 basis points over the London interbank offered rate, according to JPMorgan Chase & Co. data. Junk bond spreads dropped 5 basis points to 670 basis points over Treasuries.

High-yield bonds have returned 0.5 percent since the start of August, compared with leveraged loans, which have returned 0.2 percent, according to JPMorgan and Bloomberg data. Investment-grade bonds, rated BBB- and above by Standard & Poor’s, have yet to register a return over the same time period.

“An environment that produces just enough growth to avoid a meaningful alteration to the earnings backdrop, but not enough growth to alter the interest-rate outlook, is supportive of yields compressing,” said JPMorgan analysts led by Peter Acciavatti in an Aug. 6 report. “The fact that current spreads price in more default risk than we forecast is just icing on the cake.”

Wrong on Defaults

High-yield bond spreads imply a 4.9 percent default rate, more than double a 2 percent forecast through to the end of 2011, while leveraged loan spreads imply a 9.1 percent default rate, more than double a 4 percent default forecast through year-end 2011, JPMorgan said.

The consumer price index in the U.S. is expected to rise 1.6 percent in 2010, according to the median of 50 economists surveyed by Bloomberg News. U.S. gross domestic product is forecast to grow 3.1 percent this year, according to the median of 55 economists, Bloomberg data show.

Kyobo Life allocates about 6 percent of its portfolio to bonds issued by borrowers outside of Korea, according to Chung. Two percent is allocated in overseas alternative assets. He didn’t give a further breakdown based on geography or asset class.

The life insurer also sees investment opportunities in bonds issued by U.S. companies undergoing restructuring, said Chung.