NEW YORK, Dec 21 (LPC) - Investors pulled more than US$3bn from loan funds this week as the Federal Reserve signals additional rate increases may be slower than previously anticipated, which may deter some investors that were betting on continued increasing distributions from the floating-rate debt.
Investors pulled a record US$3.3bn from loan funds in the week ending December 19, besting the previous record outflow of US$2.5bn set the prior week, according to Lipper. It was the fifth straight week of outflows from the funds, according to the data.
The Federal Reserve (Fed) raised rates on Wednesday for the ninth time in the last three years but indicated that pace may slow in 2019. The US$1.1trn US leveraged loan market is pitched as a hedge to rising interest rates because the debt pays holders a coupon plus the London interbank offered rate. As rates rise, so do distributions, so a slower rate hike forecast may deter some investors.
The central bank statements come amid volatility in the equity and credit markets.
A benchmark of 100 of the most widely held loans fell 368bp since the start of October to 95.16 on Thursday, the lowest level since December 2011.
The Securities and Exchange Commission (SEC) warned about slow loan settlement times when it released rules to improve the liquidity risk management of open-end mutual funds and exchange-traded funds, which are popular investments in retirement savings accounts. Fed Governor Lael Brainard this month also raised concerns about loan mutual funds meeting redemption requests.
Loans settled in an average 20.3 days in 2017, according to IHS Markit. Open-end funds need to meet redemption requests in seven days.
The gap between the time it takes to settle a loan trade and the time a fund has to meet redemptions creates a possible scenario where firms struggle to complete loan sales fast enough to meet withdrawal requests.
The Bank of England in its November Financial Stability Report also warned about the mismatch, saying it is unclear how quickly loans can be sold to meet withdrawal requests without affecting market prices, even for those that have a 30-day redemption period.
“In a prolonged bull market, there is a lot of risk investors will become less aware of (issues in the market) and this liquidity mismatch is one good example of that,” said Steve Tu, a Moody’s Investors Service senior credit analyst. “Cash balances plus a revolver are still not going to cover a full redemption.”
Amid concerns about open-end fund liquidity, managers have turned to closed-end funds that do not have daily redemption requirements. Term trusts, which have a set maturity, and interval funds, which make periodic repurchase offers to shareholders, generally every three, six or 12 months, that invest not just in loans but also in Collateralized Loan Obligations (CLOs) have been popular choices.
Asset manager CIFC partnered with City National Rochdale, a unit of City National Bank, for a closed-end interval fund that will invest in CLOs, the firms announced in a news release Wednesday.
These funds can allow managers to target retail investors to broaden their buyer base, generate higher returns by investing in riskier assets without the worry of daily redemptions and also sidestep the SEC liquidity rules.
The funds are not immune to the markets, with the average senior loan closed-end fund trading at about a 12.4% discount to its net asset value. The last time it was trading around that level was in late 2015 and early 2016, according to Jeff Margolin, a closed-end fund analyst at First Trust. The discount, he says, may offer an investment opportunity.
“There’s a lot of value in closed-end funds,” Margolin said. “If an investor has the macro view that the US economy next year is not going to enter a recession, and it will grow at 2-3%, this is a good time to take advantage of a double digit discount to net asset value to buy senior loan funds.” (Reporting by Kristen Haunss Editing by Jon Methven)