Retail loan fund assets under management tumbled in May as investors sought safety from turbulent risk markets. The $7.69 billion, or 4.34%, drop is the seventh largest on record, and the most since the mass exodus of March 2020.
According to data from LCD and Lipper FMI, May’s decline in the value of assets under management in leveraged loan funds broke an 18-month run of consecutive value growth of US prime loan funds.
AUM at retail investors stood at $169 billion at the end of May, equating to roughly 13% of the $1.4 trillion leveraged loan market.
In a double whammy for asset values, both secondary prices and investor withdrawals brought down loan holdings. The US leveraged loan market in May posted its biggest monthly loss since the onset of the Covid-19 pandemic, plunging 2.56%, according to the S&P/LSTA Leveraged Loan Index. Secondary loan prices fell by a jaw-dropping 365 bps between April 30 and May 25, to 93.83, the lowest reading since November 2020. At month-end, following only a small rebound in relative terms, the weighted average bid price, at 94.64, was 284 bps lower than April’s closing price, a large move for this typically steady market.
At the same time, US loan funds posted the largest weekly outflow since the onset of the pandemic in March 2020, losing $1.6 billion for the week ended May 18. (Loan funds have since posted an even greater weekly outflow, losing $2.03 billion for the week ended June 16.) Over the last three weeks of May, $3.6 billion exited the asset class, the biggest retreat over any three-week period since the three weeks ended April 1, 2020. For the four weeks ending May 25, US loan funds and ETFs recorded $3 billion of outflows, according to Lipper weekly reporters.
This reduced the year-to-date inflow tally through May 31 to $17 billion, slightly below this point in 2021 ($17.1 billion). In all of 2021, retail investors pumped $33.9 billion into the floating-rate asset class.
(As usual, we’ll note here that in addition to weekly reporters, funds reporting monthly to Lipper are also a component of AUM, along with market value change.)
On rotation
In rotating away from risk, investors, according to a May 2022 US Fund Flows report by Morningstar, continued to run toward safer options such as government bond funds and defensive sector equity funds as fears of recession escalate. With interest rate hikes now bringing more palatable yields for investors, and virtually risk-free allocations to portfolios, government bonds hauled in $10.8 billion in May.
A focus on duration also encouraged investors to pour $9.3 billion into the ultra short bond category.
Furthermore, investors are also hoarding more cash. According to the May 2022 Credit Investor Survey by BofA Global Research, 43% of high-yield investors reported maintaining elevated cash levels, up from 40% in March.
Past times show that outside of crisis-driven AUM declines, expectations of the Federal Reserve cutting interest rates have prompted the biggest withdrawals from floating-rate loans. Except for the pandemic exit of March 2020 ($29.1 billion), and the total annual drop in AUM from December 2007 to December 2008 (which measured $23.1 billion), the next closest AUM drop on file is a loss of $19.3 billion in December 2018, a decline prompted by the Fed signaling rate-cut expectations for what would become the start of a sustained and significant decline in US Treasury yields—and loan fund outflows.
To that end, geopolitical and economic headwinds are rife, but save for an unexpected escalation of either, with a cumulative 200 bps of hikes in May, June, and July, the underlying yield driver supporting the floating-rate loan product is firmly in place until the Fed’s hiking cycle nears completion. The Street consensus to that effect calls for the Fed fund rate to peak in early to mid-2023, at a target rate of 3.75%. For reference, 10-year Treasury yields in May surpassed 3% for the first time since late 2018.
As supportive as rising rates may be to floating-rate loans (the asset class has outperformed its fixed-rate counterpart of high-yield bonds this year), Barclays analysts led by Bradley Rogoff argue higher interest rates can also be a double-edged sword for leveraged companies.
“While higher rates lead to greater coupon income for loan investors, borrowers [with floating-rate debt] are on the hook to make higher interest payments. Of particular concern is that this comes at a time when inflation is pressuring margins and the Fed may choke growth, limiting the ability to service higher debt loads,” the June 24 report states.
With fundamental concerns rising and volatility pounding the global financial markets, investors have continued to withdraw from leveraged loans in June. One week after again posting the largest weekly outflow since the start of the pandemic ($2.03 billion), US loan funds posted another giant outflow for the week ending June 22, losing $1.17 billion, according to Lipper. With this week’s outflow, about $6.16 billion has exited the market since the start of May.
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