So if the largest player in the market is not a natural buyer, what happens to the loan market if interest rate concerns dissipate and the retail outflows heat up?  Who will be there to be the source of demand?  There have been recent articles questioning how the large loan exchange traded funds will be able to handle large outflows, as unlike bonds, loans can be harder to sell given this fewer natural buyers and the more difficult settlement procedures.

We see any sort of market disruptions caused by a general exodus from the loan funds as a buying opportunity.  Secondary market players who do not face the constraints many of the others in this market face may well be able to pick up loans at very attractive prices/yields.  We are already seeing some attractive opportunities in the loan market, especially as the percentage of the loan market that now trades above par is only 50%, versus 84% at end of January7, which means we are already starting to see some opportunities for discount purchases.

We are not interested in this market due to a take on rising rates—our take has been and continues to be that we see various factors that may well keep rates low for a long time to come.  Yet, we feel this market offers some attractive yield opportunities and expands our investment universe relative to the opportunities we are seeing the high yield bond market.  If the market sentiment shifts and selling pressure in these loan funds heat up, we see this as a strong opportunity for investors like us that are active secondary players.

 

1 Current U.S. 10-yr Treasury Rate as of 5/20/14.
2  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  May 16, 2014, p. 5.
3  Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  May 16, 2014, p. 1.
4 Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “2013 Leveraged Loan Annual Review,”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  January 30, 2014, p. 94.
5 Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “2013 Leveraged Loan Annual Review,”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  January 30, 2014, p. 84.
6 Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “2013 Leveraged Loan Annual Review,”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  January 2014, p. p. 110.
7Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li.  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  May 16, 2014, p. 4.