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Why are loan fund flows losing strength?

Senior Credit Analyst

Loan fund flows were strong for most of Q2, yet over the past three weeks, they’ve lost steam

Weekly mutual fund flows reflect the sentiment of investors with respect to an asset class. While the information conveyed reflects what the market prices are already reflecting, weekly mutual fund flows can reveal underlying strength or volatility when prices seem relatively stable.

Last week, loan mutual funds saw a c. $777 million inflow. This is slightly over 22% versus the inflows the prior week, which were more in line with the $1 billion to $1.2 billion weekly inflows. Year-to-date, the flows have accumulated $28.5 billion in inflows, which dwarfs the $9.9 billion for all of 2012

(Read more: Amidst a high yield turmoil, leveraged loans keep hoarding funds)

What happened?

First, Bernanke spooked the fixed-income markets by hinting at an early tapering of quantitative easing. This statement in mid May got investors anxious about future prospects for the market. Then in June, he stated what was taken as a firm timeline to end quantitative easing by mid 2014, starting tapering as early as September 2013. This was when the high yield market (HYG) dropped like a rock a pulled leveraged loans (BKLN) down. Last week, Bernanke gave what may be his last statement as Chairman of the Fed and calmed the markets by saying the unemployment and inflation numbers are far from where they should be to stop easing.

While high yield (JNK) bounced back with a vengeance, leveraged loans failed to gather as much enthusiasm.

(Read more: Bernanke stops high yield market in its tracks; volumes freeze)

What’s next?

In the medium term to long term—meaning sometime within the next year—quantitative easing will very likely stop. This means that high yield will likely start dropping back down from its current level, probably to below the previous dip.

Leveraged loans are more complicated, because at the same time that higher rates expectations should start to benefit loans (BKLN), a stronger economy will start rallying the domestic and perhaps international equity markets. So on a relative basis, loans could trade flat or even lose ground.

Read why leveraged loans have underperformed despite their structural advantages towards bonds in a rising rates scenario.

(Read more: The difference between High Yield Bond ETFs and Investment Grade Bond ETFs)

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