Money flows back into funds investing in US leveraged loans for the first time in more than two years as investors begin to position themselves for stronger economic growth and higher inflation.
Mutual funds and exchange traded funds buying US loans raised $ 509 million for the week ended February 3, expanding a five-week inflow to a total of $ 3.2 billion, according to data from EPFR Global.
It marks the longest inflows since October 2018, ending a more than two-year streak of constant outflows from the fund group, signaling that some investors think interest rates will rise sooner than the Federal Reserve is currently indicating.
“We are a floating rate product that sets itself apart from short-term rates,” said Andrew Sveen, loan portfolio manager at Eaton Vance. “That’s one of the reasons we have fallen out of favor.”
When short-term rates rise, the rates on loans rise, making them more attractive compared to fixed income bonds. The last inflow of credit funds was broken into the last two months of 2018, with the Fed’s last rate hike in December before starting monetary easing in 2019.
Markets, by and large, have started to see higher growth and inflation as the coronavirus vaccines become more prevalent and lockdown measures wear off, leading to a sell-off of longer-dated government bonds. The US yield curve – which shows the difference between short and long term government bond yields – is at its steepest level in more than five years.
The pace of loan inflows accelerated last month after two Senate elections that gave President Joe Biden the opportunity to get his legislative agenda through Congress. Democrats pursue one $ 1.9 trillion stimulus package in addition to the $ 900 billion program approved late last year.
“Investors are positioning themselves for rising rates and historically leveraged loans have performed well in a rising interest rate environment,” said John McClain, portfolio manager at Diamond Hill Capital Management. However, he warned that expectations of this re-evaluation were “out of place”.
“I believe the front end of the yield curve will stay near zero,” he added. “The loans are near all-time highs in relation to the dollar price and have already started 2021 well, so there is far less upside potential for new investors.”
Steve Columbaro, a loan portfolio manager at Columbia Threadneedle, added that the deluge of new money pouring into mutual funds for loan has made the market a little “crowded” as investors compete to buy new loans.
However, this has been shown to be beneficial for borrowers. Some private equity groups have taken the favorable environment as an opportunity to finance acquisitions, upload already indebted companies with higher debts at lower interest rates.
Companies with high leverage have also tried to refinance existing debt and reduce their cost of borrowing.
The average return on the Loan Syndication and Trading Association’s Leveraged Loan 100 Index, which reflects the performance of the largest loans in the market, has fallen from more than 13 percent at the height of the March pandemic sell-off to just 3.78 percent.
