Leveraged loan fund exodus continues into 19th week
US loan funds have suffered their longest streak of withdrawals in more than four years, as the prospect of interest rate cuts by the Federal Reserve crimped demand for the floating-rate investments.
Investors pulled $303m from mutual and exchange traded funds that invest in US leveraged loans in the week ending July 10, according to data from EPFR Global, extending an outflow streak that began 19 weeks ago at the beginning of March. Bar one week at the start of March, investors have pulled money every week since the end of November, draining over $30bn from loan funds.
The current streak of withdrawals is the longest since April 2015, when expectations that the Fed would begin raising interest rates helped end a 38-week stretch of outflows.
Loans tend to be most in demand when investors expect the Fed to raise rates, since they provide a floating rate of interest that will rise in tandem — in contrast to bonds, whose coupons are fixed.
Expectations that the Fed has now ended its run of rate rises and will cut rates at its July meeting solidified this week following dovish congressional testimony from the central bank’s chairman, Jay Powell. The policy reversal increases the risk of a sell-off in the $1.2tn loan market.
“Because they are floating rate . . . people don’t want to buy loans,” said Peter Tchir, chief macro strategist at Academy Securities.
Investors are taking advantage of the falling demand for loans to push back against the erosion of lender protections in loan documents that borrowers were able to slip through when the asset class was hotter.
Leveraged loan prices have stayed largely flat since the beginning of June, when Mr Powell began signalling a more dovish monetary policy, while other risky assets such as equities and junk bonds have enjoyed strong returns. EPFR data showed that US high-yield bond funds pulled in $700m over the past week, while US equity funds received $1.7bn.
However, US money market funds — seen as one of the safest investments available — also drew support, taking in $26bn, according to EPFR.
“It’s a cautiously optimistic rally,” said Mr Tchir.
Bankers said that issuance of collateralised loan obligations, investment vehicles that buy leveraged loans, has helped prop up the loan market. The return of large Japanese players like Norinchukin Bank to the CLO market had boosted issuance in recent weeks.
“We are starting to see some of the Japanese buyers are back in, ramping up and buying the highly rated liabilities in the CLO structures,” said Jenny Lee, co-head of leveraged finance capital markets at JPMorgan. “That is helping.”