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US junk loan funds suffered their biggest outflows since early 2020 during the recent plunge in global financial markets, as investors fretted about the impact of a potential economic slowdown on highly indebted companies.

Investors pulled $2.5bn out of funds that invest in junk, or leveraged, loans during the week to August 7, according to data from flow tracker EPFR, with the withdrawals concentrated in exchange traded funds.

The outflows come after weaker-than-expected US jobs data at the start of August reawakened fears of a US recession, which would be likely to hurt lower-quality borrowers.

That prompted investors to dial up their expectations of interest rate cuts, with markets now pricing in four quarter-point reductions by the end of December, compared with two last month.

Leveraged loans are issued by low-grade companies with large debt piles and have floating interest payments — meaning that, unlike fixed-rate bonds, the coupons they pay to investors move up and down with interest rates.

John McClain, portfolio manager at Brandywine Global Investment Management, pointed to “meaningfully lower demand for floating-rate securities” if the market is correct about rates being cut sharply.

“Additionally we’d be getting the cuts as a result of an economic slowdown, which is bad for lower credit quality — a double-whammy for the asset class,” he added.

Column chart of Net flow data ($bn) showing US loan funds post biggest weekly outflow since March 2020

The $1.3tn loan market is widely perceived to have weaker credit quality overall than its counterpart in the leveraged finance world — the similarly sized high-yield bond market — making it more vulnerable in a recessionary scenario.

A Morningstar LSTA index of US leveraged loan prices on Monday fell to its lowest level of 2024 as the global sell-off in risky assets intensified, although it has since retraced some of those losses. McClain said the market reaction to July’s weak non-farm payrolls data was overdone, and could present an opportunity to increase exposure to the asset class for those who anticipate “slow and shallow cuts” by the Fed. 

More than 80 per cent of the loan fund outflows tracked by EPFR stemmed from ETFs. The weekly ETF outflows were at their highest level on record, according to EPFR.

But while falling yields might render the asset class less attractive to investors, lower interest rates should also help heavily indebted companies, said analysts. 

“There is a silver lining to rate cuts,” said Neha Khoda, strategist at Bank of America, “because while the appeal of loans as an asset class decreases, with a declining rate trajectory . . . The pressure for the lower-rated [borrowers] to meet higher interest costs also decreases and that actually is beneficial for projected defaults.”

A possible drop in rates “does on the margin help these companies out fundamentally”, said Greg Peters, co-chief investment officer of PGIM Fixed Income.

However, BofA’s Khoda said that if the economic outlook worsens substantially then this could affect the whole of the leveraged finance industry.

“If the trajectory of economic growth changes materially — like it did on payrolls Friday — then it’s not a question of floating to fixed — it then becomes a question of outflows from riskier parts of the credit market into safer havens.”

Join Kate Duguid, Robert Armstrong, and FT colleagues from Tokyo to London for an August 14 subscriber webinar (1200BST/0700 EST) to discuss the recent trading turmoil and where markets go next. Register for your subscriber pass at ft.com/marketswebinar and put your questions to our panel now.



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