Junk Loans Record Inflows Halting; How Concerned Should You Be?

What happens when unprecedented flows into the $1.1 trillion junk-loan market stop? Investors may be about to find out.

Investors yanked $276 million from loan mutual funds in the week ended April 16, breaking a 95-week streak of deposits, Wells Fargo & Co. data show. Leveraged loans - those rated below investment grade - are poised for their first monthly loss since August, and the biggest exchange-traded fund investing in the debt yesterday reported its first withdrawal since June, according to data compiled by Bloomberg.

Momentum is starting to shift away from high-yield loans, long heralded as a way to ward off losses from rising interest rates. Investors are reconsidering how much protection the market will actually provide as the Federal Reserve unwinds record stimulus measures that have suppressed borrowing costs.

“It’s going to be a disaster on the way out,” said Mirko Mikelic, a senior money manager at ClearArc Capital Inc., who helps oversee $7 billion of assets. “On the way in, there’s insatiable demand,” especially for higher-yielding assets with less interest-rate risk.

The recent outflow is a pittance compared with the $70.3 billion of deposits into leveraged-loan mutual funds over the prior 95 weeks, and may be just a pause. The question is how junk-rated loans will withstand more significant withdrawals from mutual funds, which own more of the debt than ever before.

The debt has lost 0.05 percent this month, according to the Standard & Poor’s/LSTA Leveraged Loan 100 Index, as other asset classes have rallied. U.S. junk bonds have returned 0.4 percent in April, Bank of America Merrill Lynch index data show, and the S&P 500 index is up 0.4 percent.

Frothy Market

Invesco Ltd.’s $7.4 billion leveraged-loan ETF reported a $24.7 million withdrawal yesterday after $1 billion of deposits this year, Bloomberg data show. The fund has lost 0.2 percent this month.

Loans aren’t regulated like bonds and stocks. They’re traded over the telephone or by e-mail, and it usually takes weeks before all the paperwork gets completed to transfer a loan from one owner to another.

They’ve come under scrutiny from regulators including the Federal Reserve, concerned there’s too much froth in the market. It’s become the norm for borrowers to eliminate many investor protections, such as limits on how much more debt companies can incur. And loans to finance takeovers are being issued at a record pace, with more than $85 billion of such debt funded so far this year, data compiled by Bloomberg show.

Let’s see what happens when the party ends.

To contact the reporter on this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editors responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net Caroline Salas Gage

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