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Why leveraged loan funds reverse 9 weeks of outflows

Phalguni Soni

Must-know: Corporate debt market reactions to FOMC minutes (Part 9 of 9)

(Continued from Part 8)

Leveraged loan funds reverse nine weeks of outflows

Five Collateralized Loan Obligation (or CLO) deals for $2.6 billion came through in the week ending July 11. This was down slightly from the previous week’s levels, when $2.8 billion was issued over five transactions. Last week brings the year-to-date (or YTD) issuance and transaction figures to $66.6 billion and 124 deals, respectively (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’re 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.

Secondary market activity

Last week, leveraged loan (SNLN) mutual funds reversed nine straight weeks of outflows, with a net inflow of $49 million in the week ending July 11. This compares to net outflows of $457 million in the previous week. Last week brings the total YTD net inflows to $1.2 billion.

Returns on leveraged loans

Year to date returns on the S&P/LSTA U.S. Leveraged Loan 100 Index have come in at 2.54%. For the week ending July 11, the Index decreased by 0.03%. As explained in Part 4 of this series, the release in the Federal Open Market Committee (or FOMC) minutes combined with signs of stress in European banks increased the yields on high-yield debt (JNK) last week, which led to a fall in bond prices.

Leveraged loans are also a lower-rated form of debt. However, as they’re issued on a floating rate basis, so to a degree they’re immune from interest rate risk, as their duration is basically the term to the next coupon payment date.

To learn about how duration can impact your fixed income investments, please read the Market Realist series, Interest rate risk: Measure and avoid the pitfalls of duration.

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