Year to forget for leveraged loans as outflows rack up
A year-long investor flight from US leveraged loans has slashed the assets of some of the largest fund managers in the market, underlining mounting unease over the prospects of some of the most debt-laden borrowers.
Investors pulled $550m from loan funds for the week ending October 23, taking total outflows over the past 12 months to $42bn, according to data from EPFR Global. There have been just three weeks of small inflows over that time.
Some of the riskiest loans in the market have started to wobble. Rating agency Fitch increased its predicted default rate for next year from 2 per cent to 3.5 per cent this week, on an expectation of further stress.
“The outflows are extreme for any fund group,” said Cameron Brandt, director of research at EPFR. “Loan funds have been whacked pretty badly.”
The outflows have hit asset manager Invesco, which bought Oppenheimer’s loan fund earlier this year. The fund has fallen from almost $16bn in assets in October 2018, to just above $9bn on Wednesday, losing its title as the largest loan fund. Invesco declined to comment.
Other fund managers have also seen large outflows. Assets in a Lord Abbett loan fund have fallen from just over $15.5bn in October 2018 to $9.6bn on Wednesday. Lord Abbett declined to comment. A comparable Fidelity fund, which reports its assets monthly, fell from $12.7bn to $9.6bn at the end of September.
Eric Mollenhauer, a portfolio manager at Fidelity Investments, said that the year of outflows was primarily the result of a policy reversal by the Federal Reserve, which is expected to cut interest rates at the end of the month for the third time this year having last raised interest rates in December 2018.
Loans typically have a floating interest rate that moves up and down in line with Fed policy, meaning cuts by the central bank can dent returns. “You have a Fed that has gone from raising rates to cutting rates . . . That is the biggest driver,” Mr Mollenhauer said.
His fund has returned 6.2 per cent this year, compared to 5.2 per cent for Lord Abbett’s fund and 6.4 per cent for the broader market, according to an index run by the Leverage Syndications and Trading Association.
Invesco’s fund has dramatically underperformed its peers, with total returns for the year of just 1.7 per cent, with the poor performance entrenched this month after coal company Murray Energy, one of its largest holdings, defaulted on $1.8bn of loans.
Ratings downgrades over the past 12 months outnumber upgrades by three to one, according to data from S&P Global Market Intelligence, up from two to one a year ago.
Almost 8 per cent of leveraged loans are now trading below 85 cents on the dollar, up from a 2019 low of 3.5 per cent in May, according to data from Citi.
At the same time, the bank’s analysts noted that the number of loans trading above their face value has also risen, from virtually none at the start of the year to almost 35 per cent in October.
“Investors have a lot of appetite for the safe, sleep-at-night credits,” said Michael Anderson, a strategist at Citi. “But there is no appetite for lower quality names.”