Loan funds on course for worst outflows on record

Loan funds on course for worst outflows on record

Investors have pulled $33bn from US leveraged loan funds this year as falling interest rates and a string of shelved deals signal a weakening of confidence in the asset class.

Mutual funds and exchange traded funds that invest in US leveraged loans have shed $2.6bn since the start of August alone and are on track for their largest annual withdrawals on record, according to EPFR Global data. The previous record for outflows was $24bn in 2015.

Leveraged loans are typically made to companies with high amounts of debt, including those taken private in leveraged buyouts.

The Federal Reserve’s decision to cut interest rates in July and signal a willingness to continue easing monetary policy damped their appeal to investors. Leveraged loans pay a floating rate of interest, which rises or falls along with market interest rates, meaning investors earn less when rates fall.

Five loan deals have been shelved over the past few weeks, including to US oil pipeline company Glass Mountain, marketing group Golden Hippo and software company Chief Power Finance., the DNA analysis group, slashed the size of its loan sale by $200m to $950m in the face of flagging investor demand, while WS Audiology, a hearing aid products company, had to tap European markets after it was forced to reduce the size of the loan it was seeking to borrow in the US.

“It is a function of the market not loving leverage,” said John McClain, a portfolio manager at Diamond Hill Capital Management. “With the volatility and money coming out of the market with expectations for a number of additional rate cuts, there has been a lot lower demand for loans.”

The Fed has shifted its policy stance after having lifted short-term interest rates nine times since December 2015. Leveraged loans soared during the period of rising rates, attracting the attention of the Bank for International Settlements, the IMF and the Fed itself, all of which expressed concern that the high demand was leading to the issuance of riskier and riskier loans.

“This is a reassessment of the market environment,” said Matthew Bartolini, head of research for SPDR, State Street Global Advisors’ exchange traded fund business. “If we’re going to have two or three more rate cuts this year the coupons on senior loans will be lower so the amount you will earn will be lower.”

Traders are pricing in a 97 per cent chance the Fed will cut interest rates by 25 basis points at its upcoming meeting in September, according to data compiled by Bloomberg, with another three rate reductions expected by the end of next year.

In the face of lacklustre demand, loan prices have slipped 0.76 per cent so far this month, according to the S&P/LSTA leveraged loan price index.

“There’s been a fair amount of publicity on the burgeoning leveraged loan market and concerns of credit quality,” said David Donabedian, chief investment officer for CIBC US Private Wealth Management. “Investors have gone for a risk off approach.”

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