(Bloomberg) -- You’d think leveraged loans might regain some of their allure as the Federal Reserve prepares to raise borrowing costs since they have interest rates that track benchmarks. Instead, individuals can’t stop hating the debt.
Mutual funds that buy loans saw $4 billion yanked last month, bringing total outflows for the 12 months ended Jan. 31 $28.7 billion, according to Morningstar data. That’s the biggest withdrawal for any U.S. debt asset class in the period.
The trend is a reversal from 2013, when individuals poured unprecedented amounts into the funds to protect themselves from losses tied to rising government-bond yields.
The outflows have continued into this year, even though the Fed is forecast to finally raise overnight interest rates from about zero, where they’ve been since 2008. The change in sentiment doesn’t make it any easier for companies and private-equity firms that rely on this market for cash.
There’s no one clear-cut reason why these funds have become so distasteful to individuals. Part of it may be that loans have gotten a bad name from regulators. The Fed has been telling banks to improve their underwriting standards and the Financial Industry Regulatory Authority has been questioning the antiquated mechanics of how the debt actually trades -- and whether that will make it difficult for mutual fund investors to get out.
RATE OUTLOOK
Another possible explanation: Lately, it’s been a good thing to be benchmarked to Treasury yields. The 6 % gains on U.S. government securities last year helped junk bonds, which would have lost money without the rally, Bank of America Merrill Lynch index data show.
There’s been “a perception that interest rates are not going to rise soon,” said Dave Breazzano, who manages more than $8 billion in high-yield bonds and loans as Waltham, Massachusetts-based DDJ Capital Management's chief investment officer. “One of the attractive features of bank loans is the floating rate aspect.”
Loans typically pay lower coupons than comparably-rated junk bonds, since they’re usually repaid first after a borrower files for bankruptcy. So if investors aren’t as worried about insulating their investments from rising rates, they’d probably go for the higher-yielding asset, Breazzano said.
Meanwhile, individuals are certainly racing back to high- yield bond funds, pouring $3.4 billion into them last week as oil prices stabilized, according to data compiled by Wells Fargo. The deposits capped the largest three-week streak of inflows on record, the data show.
While loans have managed to eke out a positive performance over the past 12 months -- with collateralized loan obligations and other institutional investors still buying the debt -- one segment is staying away.
