Why investors continue to exit leveraged loan funds



Secondary market activity: Leveraged loan funds resume trend for outflows

Net outflows from leveraged loan (BKLN) mutual funds in the week ending July 18 came in at $440 million, compared to a net inflow of $49 million the previous week. Last week brings the total net inflows in to leveraged loan mutual funds to $765 million year-to-date (or YTD) (Source: Lipper).

Part 6

Net flows, which were positive in all weeks in 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.

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Last week, Fed Chair Janet Yellen spoke of heightened risks in the leveraged loans and speculative-grade bonds segments at the semi-annual congressional testimony on July 16. She said that valuations appeared stretched and underwriting standards had fallen. The Fed and other regulatory agencies would be keeping a close eye on developments in this area. This factor affected investor flows as well.

Return comparisons

YTD returns on the S&P/LSTA U.S. Leveraged Loan 100 Index have come in at 2.47%—up to July 18. For the week ending July 18, the Index decreased by 0.07%, compared to an increase of 0.54% in the S&P 500 Index (SPY). The S&P 500 Index has benefited due to second quarter corporate results coming in slightly ahead of expectations this earnings season, including companies like Google (GOOG) and financial sector firms like Goldman Sachs, JPMorgan (JPM), and Citigroup.

The prices of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays Capital High Yield Bond ETF (JNK), which invest in high-yield corporate debt securities, declined by 0.64% and 0.60%, respectively. As mentioned earlier in this series, yields on high-yield debt increased last week due to geopolitical events in Ukraine and the Middle East. Bond prices and yields move in opposite directions, which affected returns on HYG and JNK last week.

You can read about the outlook for high-yield and leveraged loan bond markets in the next section.


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