Assets under management at U.S. leveraged loan funds jumped in December by the most in a monthly reading since May 2018. The loan market's strong finish — along with a rare (by recent standards) four-week streak of cash inflows from retail investors — increased the net asset value of prime funds by $3.18 billion in the month, according to LCD and Lipper. This bright spot comes at the end of an otherwise bruising year for the asset class, in which overall AUM contracted by $36.75 billion.
All told, that $36.75 billion decline in 2020 put the total net asset value of U.S. prime funds invested in leveraged loans at $93.5 billion at year-end, a 28% drop from December 2019, before the global pandemic took hold (note that starting in January 2020 LCD removed the iShares Floating Rate Bond ETF, which totaled roughly $9 billion, from its calculation of total loan fund assets under management). Loan fund AUM has been on a downward trajectory since its $184 billion record high in October 2018, coinciding with rate cuts, though the most staggering drop came in March 2020, when this reading fell by nearly 25%, to an eight-year low.
With loan prices rebounding as the year wore on, the change in AUM in 2020 was for the most part driven by withdrawals from the asset class. Indeed, the average bid of the S&P/LSTA Leveraged Loan Index stood at 96.19 at the end of 2020, just 53 basis points shy of where it stood at the end of 2019.
On the other side of the equation, U.S loan funds reported roughly $525 million of inflows for the four weeks ended Dec. 30, 2020. This marked the first four-week period of consecutive inflows into the loan asset class since late 2018. Nevertheless, the market hemorrhaged $19.6 billion in total loan fund redemptions in 2020.
Of note, the last consecutive four-week period of inflows in late 2018 came as investors were growing increasingly cautious about whether the already-aged credit cycle would shift the Federal Reserve's stance regarding rate hikes, and it preceded what would soon turn out to be a long, downward trek for Treasury yields.
Looking at the data through Jan. 13 of this year, the market seems ripe for some respite in 2021 from the relentless redemptions that blighted flows for much of 2020. For one, the $1.11 billion inflow for the week ended Jan. 13 came as the 10-year U.S. Treasury yield surpassed 1% for the first time since March 19, 2020.
Moreover, the U.S. Treasury yield curve has steepened to levels not seen since 2016. A steep yield curve — when there is a large spread in interest rates between shorter-term Treasury bonds to longer-term bonds — often precedes a period of economic expansion, as investors bet that a central bank will be forced to raise rates in the future to tamp down inflation. Investors subsequently will seek to adjust for rising yields, boosting demand for floating-rate assets.
According to a BofA Global Research report detailing the results of its January 2021 U.S. Credit Investor Survey, outside of the coronavirus, the main concerns for respondents were rising interest rates, the possibility of an asset bubble and inflation.
Also top of mind for investors is the potential for a return of the 2013 taper tantrum (and the subsequent backup in rates) in the event of a hawkish shift at the Fed. Nevertheless, per LCD's leveraged loan survey conducted in December, slightly more than a third of respondents (35%) expect 10-year U.S. Treasury yields will be between 1% and 1.49% at year-end 2021. This would suggest some participants are expecting only a modest increase, even as the market awaits more clarity on the timing of the central bank winding down its asset purchase program.
Aside from retail demand, which represents a relatively small portion of the overall demand for leveraged loans, CLO supply and warehousing are expected to pick up this year. BofA and Citi, for example, in their market outlooks forecast 2021 CLO supply of $110 billion and $100 billion, respectively. This compares to $93 billion issued across 218 deals in 2020.