June 13, 2019 / 8:44 PM / in a month

Loan market reels from rumored rate cuts

NEW YORK, June 13 (LPC) - Market expectation that the US Federal Reserve will cut rates, possibly as early as this year, has sent investors fleeing the loan market.

A total of US$686.1m was pulled from loan funds the week ending June 12, according to Lipper, following the largest outflow this year in the previous week, which totaled US$1.472bn.

High yield bond funds saw a similar spike in outflows in the week ending June 5 with US$3.2bn withdrawn, the highest since December, Lipper data showed. The latest figures showed a US$1.7bn inflow to high yield funds.

Loan funds make up just 11% of the total leverage loan market, according to LPC, a historic low since mid-2016. Combined loan fund and ETF assets under management (AUM) dropped to US$137bn in May, a new low.

More than half the loan market demand stems from collateralized loan obligation (CLO) funds, which after a slow start this year have begun to pick up. Separate managed accounts made up 38% of demand, according to LPC Refinitiv data.

SECONDARY VALUE

With primary issuance still in the doldrums, loan investors are increasingly looking to the secondary loan market for value. The LPC Leveraged Loan 100 was at 97.87 on June 12, while the number of loan bids quoted above par remains at just 7%.

Retail and the oil and gas sector are the biggest drags on secondary pricing. Other sectors such as technology, auto, healthcare and plastics have not yet recovered to their levels at the pre-November rout.

“Very few loans are trading above par and the market is very small, so there is a bit of a stalemate in the near term, which is resulting in increasing demand in the secondary market,” said Andrew Carlino, managing director at Bain Capital Credit. “Right now, everything in the secondary market feels reasonably balanced.”

With still value to pick up in the secondary market, the change in appetite for loans has left some market participants reeling.

“As a market we’ve got to better educate investors on the benefits of loans. There is more to the asset class than a rising rate hedge,” said Frank Ossino, senior managing director at Newfleet Asset Management. “In 2017, when we saw inflows, 66% of the market was trading at par or higher above par. Year to date that number has averaged around 9% but we still see retail redemptions. Retail investors are buying when we’re at par and not buying when there is more value in the market.”

Investment firms, however, are trying to stay nimble and have established pooled funds that combine exposures to both instruments when appetite shifts again.

Newfleet has established a fund to invest across both asset classes from a single pool of capital and KKR announced in January it would take an opportunistic approach to investing in sub-investment grade credit, allowing for managers to “respond to current market dynamics”.

Other hedge funds have marketed collateralized debt obligation vehicles to invest in both asset classes in recent years.

“The spread differential between bonds and loans is reasonably low,” said John McClain, a portfolio manager at Diamond Hill. “There are pockets of value in the secondary loan market, some inter capital structures where you can move up into a securitized position and not give up much yield.”

Reporting by David Brooke. Editing by Michelle Sierra and Jon Methven

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