While the CLO market still struggles to get back on its feet, the bank loan retail mutual fund market appears to be off and running.
Since the start of year, three bank loan retail funds have launched, the first new funds since December 2007, market participants say.
New mutual funds signify that managers are aggressively seeking retail clients, something new the loan market.
And market participants don’t expect the three new funds — the RS Investment Management Floating Rate Fund, the Neuberger Berman Floating Rate Fund and Delaware Investments’ Diversified Floating Rate Fund — to be the last. Several sources say they’ve heard of a number of managers working on new bank loan retail funds.
This is good news for the bank loan market because more funds equal more liquidity.
“The stream of new entrants is confirmation that this asset class has gained wide acceptance as a standard offering to retail investors,” a Boston-based portfolio manager said.
At the end of last year, bank loan mutual funds made up around 10% of the bank loan market’s investor base; that’s double the presence they had in 2008.
Bank loan retail funds, sources said, are an attractive investment choice right now for investors because it’s not a question of if interest rates are going to rise, but when. And because of the nature of bank loans, a rising interest rate environment is good for bank loan investors.
The new funds “point to investor appetite for floating-rate hedges against high yield bonds and against the Federal Reserve raising rates down the road,” a New York-based investor said.
Recent inflows into bank loan retail funds have been strong. For the week ended March 17 — the most recent data compiled — inflows into bank loan retail funds totaled $230 million, according to Lipper FMI, formerly know as AMG Data Services. This continued a 16-week winning streak, during which $2.7 billion has poured into these funds.
Indeed, while other domestic sectors haven’t seen much in terms of inflows year-to-date, the bank loan market has seen a steady stream of cash flowing in, said Robert Adler, head of Lipper FMI Americas. “There is smart money from institutional trading desks coming into the bank loan market. This is an indicator of rising rates, and it’s a positive for the market. It means banks are going to lend to credit-worthy borrowers intent on recapitalizing and rebuilding from lost business. That is good news to lead other business out of the recession.”
Moreover, the net asset value (NAV) of this corner of the market grew by $60 million during the week ended March 17, according to Lipper FMI. That followed a $72 million increase the previous week and an $88 million increase the week prior to that. For the week ended March 17, inflows combined with the increase in NAV raised total assets by $290 million to $17.4 billion.
“Substantially all closed-end funds are trading at premiums to NAV,” a Connecticut-based investor said. “This is very rare and usually results in the successful launch of new closed-end bank loan funds.”
The Boston-based portfolio added, “Closed-end funds trading at premiums are a bullish signal. Investors are in a yield desert, and these funds appear as a water source. Still care should be taken as premiums tend to be unstable if not unnatural.”
With so much activity surrounding bank loan retail funds, some market participants even hypothesized that these funds could one day be a more significant buyer of loans than CLOs.
“Given the dearth in CLO issuance, new loan funds are a logical candidate to step in to replace the decline in CLO market share,” the Connecticut-based investor said. “We’ve already seen a few new entrants; it’s only a matter of time before other fund managers come to market. And first movers will have the advantage.”
However, other market participants don’t believe retail funds will become the “new CLOs” of the loan market. “CLOs are a way to lever up loans multiple times and are supported by desire for triple-A-rated paper at yields better than double-A-rated paper,” said a second Boston-based investor. “I don’t see retail funds as replacing those key elements of demand.” However, he said, if interest rates start climbing, “I expect bank loan retail funds will be favored for their floating rates with a spread—a combination that’s hard to get in the investment world.”
Still, some market participants have reservations regarding some fund managers and whether they have the experience to keep these new funds on their feet.
“Over the years, we’ve seen managers come and go. There are some tricks and traps,” said the first Boston-based portfolio manager. “Still, overall it’s good to have more players and to see retail engagement grow. Also, I think the increased interest reflects well-placed and growing concerns about fixed-rate bond risk, which could attract more investors to floating-rate funds.”
