As risk assets rallied, investors migrated to
the high yield market, which saw relatively
steady retail inflows to start the year. With cash
available from dividends and the exodus of
over $30B1 in issuers that were upgraded to
investment grade, the overall supply/demand
picture for high yield has been one of
significant excess demand.
High yield bonds are being used increasingly to retire loans – a reversal from the dynamics at play in prior years – but the demand from investors has been more than ample enough to soak up new issue supply. Similar to the loan market, negative market events could cause retail flows to reverse, potentially upsetting the favorable technical picture in the high yield market today.
Loan funds have seen continuous outflows for 32 straight weeks2 as investor demand for floating rate products waned following the decline in interest rate expectations following the Fed’s dovish pivot. While retail fund flows have been negative, mutual funds and ETFs only compose around 9%1 of the overall loan market, so retail demand, or lack thereof, can be subsumed by institutional demand. That has largely been the case so far in 2019, as the market has been buoyed by CLO issuance, which is only slightly off pace compared to 2018’s record-setting year. In addition, gross and net loan issuances are down roughly 70% and 29%,2 respectively, year over year.
This combination has helped keep the supply/demand relationship in check, which in our view is supportive to overall returns. It certainly bears monitoring. If either of these factors change, it could impact the outlook for steady returns in loans. An increase in expectations for additional rate cuts could cause an acceleration of retail outflows, and increased concerns about an economic contraction could impact CLO creation, further reducing demand.
1 J.P. Morgan.
2 S&P/LSTA Leveraged Loan Index.
All data as of June 30, 2019, unless otherwise noted.
Indexes: High yield bonds represented by the ICE BofAML High Yield Master II Index. ICE BofAML U.S. High Yield Master II Index is designed to track the performance of U.S. dollar-denominated below investment grade corporate debt publicly issued in the U.S. domestic market. Loans represented by the S&P/LSTA Leveraged Loan Index. S&P/LSTA Leveraged Loan Index is a market value-weighted index designed to measure the performance of the U.S. leveraged loan market.
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