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High-yield debt funds see record outflows and bonds rally

Part 6
High-yield debt funds see record outflows and bonds rally (Part 6 of 7)

Must-know: Why collateralized loan deals continue to thrive

Collateralized debt obligations

Collateralized debt obligation (or CLO) deals continued to find favor with both issuers and investors. Seven CLO deals for $4.1 billion came through in the week ending August 8. This was up from the previous week’s levels, when six CLO deals for total issuance volumes of $3.1 billion came through. Last week brings the year-to-date (or YTD) issuance and transaction figures to $78.5 billion and 144 deals, respectively (Data source: S&P Capital IQ/LCD).

The market for CLOs has touched new highs in 2013 and 2014 with a record number of transactions and issuance volumes. Low yields on safer debt securities like investment-grade debt (BND) have forced investors to “reach for yield” in high-yield debt (HYG) and leveraged loans (BKLN).

CLOs have certain advantages for investors because they are able to slice credit risk into tranches. As a result, an investor with a low risk appetite may get exposure to AAA-rated debt tranche in a CLO, while an investor with a higher risk tolerance can earn higher yields by investing in lower rated tranches.

Part 6Enlarge Graph

Leveraged loan funds continue to see outflows

Net outflows from leveraged loan (BKLN) mutual funds in the week ending August 8 came in at $1.5 billion, compared to a net outflow of $406 million in the previous week. Last week brings the total net inflows in to leveraged loan mutual funds to $1.6 billion YTD (Source: Lipper).

Net flows into mutual funds provide clues as to investor sentiment regarding the asset class. Leveraged loan flows, which were positive in all weeks in the 1Q14, have been steadily eroded since the 2Q14, as the Fed continues to reiterate its commitment to monetary accommodation.

Leveraged loans are issued on a floating rate basis. While issuers benefited from the low yields scenario brought about by an accommodative monetary policy, investors preferred to exit due to the prospect of low and declining yields.

A number of Fed officials, including Fed Chair Janet Yellen, have warned of signs of froth and lower underwriting standards in the leveraged loans and junk-rated bond markets. The Fed’s latest report issued last week, surveying senior bank loan officers about lending practices, came to the same conclusion.

You can compare returns on high-yield debt with other assets classes including stocks (SPY) and investment-grade bonds (AGG) in the following section.

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