Although the potential rise in interest rates has placed a damper on most asset classes, the syndicated loans world has not lost its appeal. Instead, loans have probably been one of the most attractive asset classes around this year, and they are spurring the creation of new loan funds as well as collateralized loan obligations (CLOs).
"Both the CLO and retail fund market have been very strong and there is no indication that is going to end any time soon," said Mike Bacevich, a senior vice president at Hartford Investment Management, a wholly owned subsidiary of The Hartford Financial Services Group.
Bacevich manages a recently launched loan fund for Hartford. The company hired him along with four other loan officers from Cigna, and they brought over $750 million in loan assets that they had managed there. "Hartford saw the opportunity to hire a good team that was already in place to do loans," he said.
At a time in which credit markets are relatively benign, investors are comfortable with putting their money in subinvestment grade assets like leveraged loans, Bacevich said. At the same time, though, the possibility of a rise in interest rates leads many to turn toward safer instruments, and this makes loan funds attractive, Bacevich said. Over the past year or so, many managers have been able to raise a lot of money, so institutional managers are probably looking to introduce retail funds and vice versa, he says.
Many managers are keen to make money out of the cash that they have been raising, but in a safe environment like the loans world, said a portfolio manager who declined to be named. Yet while it might be easy to conceptualize new loan funds at this time, their potential for success is debatable, the manager said. Loans are inherently low-risk, low-return instruments, from which it is difficult to generate decent returns unless some leverage is employed, and this would mean added risk, he said.
"Loans are undoubtedly a good place to put money in this environment, but at some point, there is a threshold where investors would rather sit on cash," the fund manager said. "If I am retail investor, I would rather sit on cash and get a 1% return than put my money in a loan fund that yields, say, 2%."
But more significant than possible new loan funds is the pipeline of high yield loan-backed collateralized debt obligations (CDOs). There are about $3.7 billion new transactions in the works from both US and European issuers, sources say, and year-to-date, high yield CLOs have accounted for about 15% of the market volume, or $11 billion of the $75 billion priced (HYR 5/31).
Why CLOs? Well, more than any other vehicle, these structured products offer people access to the leveraged loan market, said Tom Finke, head of David L. Babson & Company Inc.'s US loan business, over 60% of which is invested in CLOs. Loans have also proved their resilience through credit storms - "whether it be at the triple-A or the equity level, CLOs have weathered the downturns in the credit cycles, and so people see them as tested vehicles," Finke said.
While established CLO managers are putting together new vehicles (Finke would not comment on Babson's plans), it's likely that there will be some new entrants to the field as well, he said. However, whether a new player is successful will depend on sponsors, the management team that is selected and how they do business, Finke said.
"It is harder to be a new player now than it was five years ago because the market is more discerning," he said. "An existing player with a good track record will be better off than a new entrant, but that is not to say that you aren't going to see any new players in this business."
There are some, though, who question the viability of launching a new CLO in the US at this time. To be sure, spreads are at very tight levels, a CLO source said, and the demand for loan paper, albeit slightly tempered of late, is on the whole voracious.
"Many managers are reaching far and wide for assets, paying well over par in the ramp-up, picking up paper with very tight spreads," the CLO manager said. "To offset the lower yielding spreads they're getting, they are often picking up discounted, high coupon paper with a greater level of risk, thereby exposing the vehicle to early default."
Certainly, spreads have come in a great deal, Finke agreed, and loan assets are costly. However, liability spreads on CLOs have also tightened, and so there are still arbitrage opportunities, he said.
Over the past couple of years, high yield CLOs have proven to be far stronger than their bond counterparts, Finke said. With the number of tests the CLO/CDO world has to undergo and a market that is overall far more conscious about credit quality, CLOs should shine again, even in the event of a downturn.
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