The influx of cash into high-yield portfolios has sent some bond fund managers rushing toward bank loans instead.
Managers from
Fidelity Investments, Loomis Sayles & Co. LP and Eaton Vance Corp. who have the freedom to invest in multiple asset classes are replacing their exposure to high-yield bonds with bank loans.
Bank loan funds exploded in popularity in late 2010 and early 2011 as investors clamored for the safety of a fixed-income instrument that could benefit from rising interest rates. Bank loans are securitized debt issued by below-investment-grade companies to finance operations.
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The loans' interest rate is tied to a benchmark, typically the London Interbank Offered Rate.
Between September 2010 and July 2011, bank loan mutual funds had inflows of more than $30 billion, according to Morningstar Inc. However, by mid-2011 it was apparent there was no imminent interest rate hike on the horizon, and flows turned negative, with such funds losing $10 billion during the second half last year.
For most of this year, flows into such funds have been positive, but tepid.
Over the past two months, however, bank loan funds have experienced inflows of $3 billion, more than half the total so far this year.
The renewed interest is as much about the attractiveness of bank loans as it is the unattractiveness of high-yield bonds, experts said.
Both asset classes offer income-seeking investors relatively attractive yields, with bank loans around 5.5% and high-yield bonds around 6.5%.
But high-yield bonds have been far more in favor this year, driving prices to records. Managers are worried that investors chasing after yield could be easily spooked, dragging down returns in the process.
High-yield-bond funds had about $10 billion in net inflows over the past two months, with nearly a third of that through the end of last month.
The surge of buy orders pushed year-to-date inflows to a record $34.5 billion, $7 billion more than the past two years combined, according to Lipper Inc.
Year-to-date through Oct. 17, the high-yield-bond category at Morningstar had posted a 12% return; bank loan funds had posted an 8% return over the same period.
“There's a lot of fast money in there, the earliest signs of trouble that money is out the door,” said Jurrien Timmer, director of global macro
portfolio management at Fidelity.
Bank loans and high-yield bonds have basically the same fundamental thesis. Because the assets are rated below investment-grade, the largest threat is default.
Corporate profits have never been higher, though, which puts default risk relatively low.
Although the credit risk between the two asset classes is the same, the interest rate risk is a completely different story. Because bank loan rates would rise along with interest rates, they effectively have no duration risk.
The combination of no rate risk, below-investment-grade yields and relative cheapness when compared with high-yield bonds is what led Mr. Timmer and others to bank loans.
Bank loans aren't without a downside, though. If the economy starts to look worse and default expectations rise or investors simply go “risk-off,” bank loans will be one of those risk asset classes that is sold off.
Tom Luster, director of investment-grade fixed income at Eaton Vance, is happy to take on that risk, rather than the risk of rising rates.
“We'd rather go three steps out on credit risk than one step out on interest rate risk,” he said.
Peter Palfrey, portfolio manager of the $1.4 billion Loomis Sayles Core Plus Bond Fund (NEFRX), is in the process of building up the fund's bank loan position, which stands at about 2%, an all-time high.
[email protected] Twitter: @jasonkephart
