A frantic race for bank loan funds is running out of steam.
Investors poured tens of billions of dollars into the funds over the past year, betting that floating-rate debt would help them weather the next wave of interest rate hikes by the US Federal Reserve.
Now fears that Russia’s invasion of Ukraine and rising energy prices will slow the US economy have some investors wondering if the Fed will raise interest rates as aggressively as expected. just a few weeks ago. That, in turn, sapped interest in the funds, which saw net inflows of $15.1 million in the week ending March 9, compared to $179.1 million the previous week and a record $2.29 billion the week of Feb. 9, Refinitiv Lipper said.
According to Refinitiv, the pace of new funds pouring into bank loan funds has slowed for four straight weeks.
“Everyone is rethinking the amount of rate hikes we’re going to see,” said Brian Juliano, a portfolio manager at PGIM. “People look at asset class outperformance and ask, ‘Did I miss the boat?’”
Fed officials voted on Wednesday to raise the benchmark federal funds rate by a quarter of a percentage point, the central bank’s first rate hike since 2018, and signaled they would raise rates six times by more this year.
Unlike other forms of corporate debt, including junk bonds, bank loans offer payments that rise or fall with the benchmark rate at which financial institutions lend to each other. They generally yield less than high yield bonds, but perform better in times of rising interest rates than fixed income securities.
Investor interest in bank loans increased late last year as many concluded that the rise in consumer goods and commodity prices would not slow anytime soon, prompting the Fed to tighten monetary policy. Flows into variable-rate funds accelerated this year as economists began to predict the Fed would raise rates faster than expected.
The funds, for which money from new clients has exceeded withdrawals for 13 straight weeks, started the year on a high. Their all-time best three weeks for net inflows were in 2022, Refinitiv said.
Returns from bank loan funds have outpaced nearly every other taxable debt investment category over the past year, including high-yielding and highly rated bond funds, Refinitiv said. As of March 10, loan funds had grown an average of 1.15% over the past 12 months. Junk bond funds were down 0.77% over the same period.
The fund’s jump in popularity has coincided with an increase in the supply of loans. Banks issued a record amount of leveraged loans in 2021 amid a wave of private equity buyouts, offering managers of floating rate funds from firms including PGIM, Morgan Stanley’s Eaton Vance Management and Lord Abbett & Co. many offers to choose from.
The worst-case scenario for bank loan investors would be an economic downturn that hampers companies’ ability to repay debt.
So far, fund managers say they see little sign of that. “We still have historically low default rates,” said Kearney Posner, portfolio manager at Lord Abbett. “Earnings are strong. Consumers have been bolstered by stimulus and monetary policies.”
Inflation often spikes in wartime, Posner said, and the Fed will have to raise rates to get it under control, even if it does so more gradually.
And even if the economy deteriorates, bank loans could fare better than other corporate debt, said Christopher Remington, institutional portfolio manager at Eaton Vance.
“When the stock market catches the flu, high yield catches a cold and bank lending suffocates,” Remington said. “It’s the cosmic order of things.”
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