Leveraged loan assets under management hit 2-year high as Treasury yields rise

The U.S. leveraged loan market continues to attract retail fund flows in asset allocations as investors seek a cushion against rising rates and duration concerns.

According to LCD, loan fund assets under management grew by $4 billion in September, the highest monthly growth since June in what now amounts to 11 consecutive monthly increases in the value of managed U.S. exchange-traded funds and mutual loan funds.

This brings total loan fund AUM to $136.8 billion, the most since summer 2019, according to LCD and Lipper. Fund assets are now just a little under $50 billion shy of the October 2018 peak, when prime funds topped $184 billion.

There was a greater month-over-month contribution from rising secondary prices to the value of loans under management in September. Secondary loan prices rallied to their highest level in nearly three years, with the weighted average bid of the S&P/LSTA Leveraged Loan Index advancing to a new pandemic-era high of 98.62 by Sept. 30, up 37 basis points from August.

In August, by comparison, the weighted average bid of the index rose 21 bps during the month to 98.25, and in July, prices fell 35 bps.

Meanwhile, funds that report weekly to Lipper FMI tallied $2.1 billion of inflows in the four weeks ended Sept. 29, nearly unchanged from the previous four-week reading. The loan market has enjoyed a near-unblemished record of inflows, totaling $26 billion in 2021 through the end of September, with only two minor blips amounting to less than $80 million of outflows during that period.

From an asset allocation perspective, spreads on high-yield bonds and bank loans continued to tighten in September. The yield to maturity on the S&P/LSTA Leveraged Loan Index dipped to a new record low Sept. 30 at 4.19%, and the yield-to-worst on the S&P U.S. High Yield Corporate Bond Index again dipped below 4%, to 3.97%.

By the Oct. 22 close, the measures had converged to 4.17%.

In protecting returns, investors often flock to floating-rate products like leveraged loans over high-yield bonds during periods of rising rates as duration concerns come back in focus.

U.S. Treasury yields have risen sharply in recent weeks, the benchmark 10-year note adding 22 bps in September to close at 1.52% before reaching a five-month high of 1.7% on Oct. 21.

Looking ahead, the vast majority (96%) of market pros per LCD's quarterly survey of buy-side, sell-side and advisory firms believe that inflation will be at or above the Fed's policy target of a 2% average and, arguably, not transitory, which could pressure the U.S. central bank to accelerate its timeline for raising rates. Per LCD, nearly 50% of respondents said they expect to see the Federal Reserve raise rates in the second half of 2022. In the second quarter, only 37% expected this to be a second half of 2022 event.