ETF Fervor Shifts to Loans as Bonds Lose Luster: Credit Markets
Exchange-traded funds that amassed junk bonds at a record pace in the first half of 2012 are now attracting unprecedented cash to buy speculative-grade loans as investors wager that a four-year rally in the notes is ending.
Blackstone Group LP (BX), the world’s largest private-equity firm, is planning its first ETF that will mostly buy loans, and Pyxis Capital LP, spun off from Highland Capital Management LP, announced its first such fund last week. Invesco Ltd.’s PowerShares Senior Loan (BKLN) fund, started two years ago as the first ETF solely dedicated to loans, has grown to become the third- biggest speculative-grade debt ETF with $1.2 billion of assets.
ETFs, which allow investors to speculate on securities without actually owning them, are shifting into floating-rate senior loans as concern mounts that junk bonds are losing momentum after gaining 114 percent since 2008. The gap between yields on bonds and loans has fallen to less than half the historic average amid the Federal Reserve’s actions to stimulate the economy.
“Loans are a compelling asset class compared to high yield at these levels,” said Jason Rosiak, the head of portfolio management at Pacific Asset Management, the Newport Beach, California-based affiliate of Pacific Life Insurance Co. “ETFs regardless of the asset class are becoming a more widely used vehicle to express a view.”
Flows into ETFs that buy bank debt reached a record $124.2 million in the week ended Oct. 24 and have accounted for 17 percent of all deposits into leveraged-loan funds since July, according to data compiled by Royal Bank of Scotland Group Plc. The average trading volume in PowerShares loan ETF shares has surged to 1.5 million over the past five days, almost three times the average over the past six months, according to data compiled by Bloomberg.
The five-biggest ETFs that focus on speculative-grade corporate notes have lost $1.61 billion of assets since reaching a peak of $32 billion on Sept. 20, while the funds that buy loans on such companies reported $467.6 million of deposits.
Yields on junk bonds were 42 basis points more than those on loans as of Nov. 9, according to JPMorgan Chase & Co. (JPM) data. That compares with an average 103 during the past three years. Loans were paying as much as 13 basis points more than junk bonds in mid-September, the analysts said.
Leveraged loans are the latest assets to benefit from ETFs that have attracted buyers from retirees to the biggest banks because they’re easier to trade than the underlying debt. Loans trade less frequently than bonds, are only available in over- the-counter markets to institutional investors and may take weeks to officially change hands after a sale. Shares of an ETF trade like stocks and prices are reported in real time.
“Investors have said they want another way to manage their portfolios,” said Diane Vazza, the head of Standard & Poor’s global fixed-income research in New York. “High-yield ETFs were a natural. Loans are an extension of that.”
Elsewhere in credit markets, Volkswagen AG is said to be planning a sale of dollar-denominated debt in a three-part offering that includes fixed-and floating-rate notes. Principal Financial Group Inc. (PFG), the seller of life insurance and retirement products that is acquiring Chile’s AFP Cuprum SA (CUPRUM), is said to be offering $800 million of bonds in three parts to help fund the purchase.
The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, fell from the highest in more than three months, declining 1.3 basis points to a mid-price of 105.3 basis points at 12:05 p.m. in New York, according to prices compiled by Bloomberg.
The indexes typically fall when investor confidence improves and rise when it deteriorates. Credit swaps pay the buyer face value should a borrower fail to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million.
Volkswagen, the car manufacturer with $12.6 billion of bonds maturing next year, intends to sell two-year notes with a floating coupon and fixed-rate three- and five-year securities, according to a person familiar with the offering who asked not to be identified because terms aren’t set. The bonds will be issued through the Wolfsburg, Germany-based company’s Volkswagen International Finance unit, the person said.
Principal may sell debt due in 2017, 2023 and 2043 as soon as today, according to a person familiar with the transaction. Each portion will be at least $250 million.
Proceeds will help fund a tender offer for Cuprum shares, the Des Moines, Iowa-based company said today in a filing. Principal is acquiring Chile’s fourth-largest pension manager for $1.5 billion as it looks to add fee income from Latin America. The new bonds will be redeemed at 101 cents on the dollar if the deal is not completed by Nov. 19, 2013.
Blackstone is working with State Street Corp. (STT) to create the Blackstone/GSO Senior Loan Portfolio, which will seek to invest at least 80 percent of its assets in leveraged loans and trade under the ticker SRLN, according to a filing with the Securities and Exchange Commission on Oct. 31.
The fund, which aims to return more than the S&P/LSTA U.S. Leveraged Loan 100 Index, will be overseen by Blackstone managing directors Daniel McMullen and Lee Shaiman, the document said. It differs from Invesco’s leveraged-loan ETF in that it will be actively managed, rather than seeking to mirror the returns of a benchmark index.
Pyxis Capital, which is based in Dallas, and has $2.4 billion under management, started the Pyxis iBoxx Senior Loan ETF on Nov. 7, the company said in a statement. The fund, which trades under the ticker SNLN, seeks to track the returns on the Markit iBoxx USD Liquid Leveraged Loan index.
Investors funneled $568 million into U.S. leveraged-loan funds in the five days ended Nov. 7, the most since the week ended May 18, 2011, with $99 million going to ETFs, according to data compiled by RBS. The loan funds have reported $3.3 billion of inflows since Sept. 12 while junk-bond funds in the region reported $427 million of withdrawals, the data show.
In the first five months of the year, the biggest junk-bond ETFs increased their assets by $8.16 billion, Bloomberg data show.
“People are searching for yield,” said Deborah Fuhr, who helped found the London-based research firm ETFGI this year after heading ETF research at money manager BlackRock Inc. “It’s harder to find products that historically have been able to generate junk-bond level returns.”
Yields on speculative-grade bonds plunged to a record low of 6.84 percent on Oct. 18 before rising to 7.1 percent on Nov. 9, according to Bank of America Merrill Lynch index data.
Investment managers are increasingly turning to ETFs since it’s easier to allocate money by purchasing shares sold at $100 or less, Fuhr said. Bonds are typically available for sale in $1,000 increments.
The notes have had annualized returns of 22 percent since December 2008, when the Federal Reserve began holding its benchmark interest rates at zero to 0.25 percent. The central bank also plans to buy $40 billion of mortgage bonds a month in its third round of debt purchases aimed at igniting an economy that’s expected to grow at a rate of 2 percent next year, according to economists surveyed by Bloomberg.
Leveraged loans have returned 9.3 percent this year and 58 percent since 2008, when spiraling declines in mortgage values led to the demise of Lehman Brothers Holdings Inc.
Loan investors usually play a more active role in determining new covenants protecting creditors than bond buyers and may choose to allow a company to amend existing deal documents, according to Robert Cohen, a senior credit analyst at Los Angeles-based DoubleLine Capital LP, which oversees $45 billion in assets.
Investors also may want their fund managers to have expertise in estimating the potential recovery on distressed credits from the leveraged-buyout boom from 2005 through 2007, which are a significant part of loan indexes, he said.
“All of these issues suggest that active management is the way to go,” Cohen said in an e-mail.
Invesco’s ETF has gained 8.7 this year, 0.64 percent less than the S&P/LSTA Leveraged Loan 100 Index that it seeks to match, Bloomberg data show. It has increased its assets by $1.1 billion this year with its share price rising $1.01 to $24.82, the data show.
“Because of the really strong demand for high-yield bonds that we’ve seen for the past year, they’re now yielding about the same as bank loans,” Rosiak said. “In the near term, I’d rather be higher up in the capital structure and floating-rate with loans.”
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