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Why refinancing deals crowded the high yield bond market

Part 6
Why refinancing deals crowded the high yield bond market (Part 6 of 6)

Positive fund flows reflect strength in the leveraged loan market

Strength continues

The leveraged loan market (BKLN) had an inflow of $327 million last week, maintaining a very strong and steady pace for several months now. While this is lower than the $527 million from the previous week and $358 million two weeks ago, it marks the 92nd straight week in a row of cash inflows. Of the total, roughly 16% of inflows were tied to the ETF segment.

Leveraged Loan funds flowEnlarge Graph

The four-week trailing average dipped to $483 million, from $504 million last week and $510 million two weeks ago. Year-to-date inflows totaled $6.5 billion, compared to last inflows of $12 billion during the same period.

The S&P/LSTA U.S. Leveraged Loan 100, which tracks the 100 largest loans in the broader index, gained 0.31% for the month ending March 25, 2014. The index provided an annualized one-year return of 4.37%.

The major ETF that tracks the S&P/LSTA U.S. Leveraged Loan 100 index is the PowerShares Exchange-Traded Fund Trust II (BKLN). Many investors favor leveraged loan ETFs to negate the effect of rising interest rates. Leveraged loans normally pay a floating interest rate above LIBOR1, which adjusts with changes in interest rates.

Another major leveraged loan ETF is the Pyxis/iBoxx Senior Loan (SNLN). The ETF comprises about 100 of the most liquid, tradable leveraged loans, as identified by Markit’s Loans Liquidity service.

These ETFs—with top holdings in Clear Channel Communications, Inc., (CCMO) and Dell International LLC (DELL)—have posted an outflows $43.5 million and $0.45 million, respectively, last week.

Outlook

Returns from leveraged loan ETFs are better placed than high yield bond (HYG) ETFs in terms of interest rate volatility, as the underlying loans are usually of a floating-rate nature and are benchmarked to the London Interbank Offer Rate (or LIBOR). Plus, leveraged loans also have some surety in terms of their investment being backed by the issuing company’s assets. Consequently, the issuer company also doesn’t need to pay a premium as high as in the case of high yield bonds to sell these securities. So, loans have lower quoted yields than high yield bonds.

Leveraged loans also suffer from credit risk, much like high yield bonds (JNK). However, with an improving economy, the credit risk associated with leveraged loans or high yield bonds is reducing, bringing credit spreads down. As leveraged loans are secured by the company’s assets, and as they offer investors protection against interest rate hikes, investors may continue to favor leveraged loans over high yield bonds in the current environment.

To learn more about investing in fixed income securities, check out Market Realist’s Fixed Income ETFs page.

  1. “LIBOR” stands for the “London Interbank Overnight Rate,” and it’s the benchmark interest rate for many adjustable-rate mortgages, business loans, and financial instruments traded on global financial markets. Currently, the three-month LIBOR is 0.24%.

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