Why are investors switching to loans?
Loans enjoyed a spectacular run in the US last year and 2013 looks set to bring more of the same.
In the second week of February there was a $1.5 billion inflow into US loan funds, 2.5% of total net assets, according to BAML. Indeed, average weekly inflows throughout 2013 have equalled 1.5% of total assets. Flows in Europe are starting to follow suit.
This intense focus on loans is a by-product of two things: investor nervousness around the impact on fixed income of interest rate rises and investor nervousness around bond market returns. "As there is more stress around duration risk and the fixed-income market becoming too tightly priced, loans look like terrific value – particularly in the US, where there is a greater prospect of rate rises as leading indicators are more positive," says Martin Horne, managing director at Babson Capital in London. "We were making the case for loans even when bond spreads were slightly wider than loan spreads," he says. "Bonds are largely unsecured and carry duration risk, loans are secured, with no duration risk."
Tripp Smith, senior managing director at the Blackstone Group and a founder of GSO Capital Partners, believes, however, that the market momentum is simply the by-product of the irrational pricing in leveraged finance. "If both products are offering similar yields, as they are at the moment, then investors should move into loans from high-yield bonds as they are senior in the structure and floating rate," he says, warning that, "investors are chasing yield in the high-yield market hoping that they can be the first one out if rates start to increase."