Wall Street's fixed income darling BLF returns, these risks must be known

In the recent turbulent US stock market volatility, bank loan funds, which were often regarded as dregs by investors before, have once again sprung up. Some income-oriented investors in pursuit of high returns have been returning to this field. Entering the beginning of 2021, "Bond King" Jeffrey Gundlach (Jeffrey Gundlach) also recommended bank loan funds for fixed income investors.

So, what is a bank loan fund? Bank Loan Funds (BLF, Bank Loan Funds), as the name suggests, are mutual funds used to purchase loans from banks (or other financial institutions) to companies.

Wall Street banks usually issue such loans to companies in leveraged buyout transactions and then sell these loans to institutional investors and mutual funds. These loans are usually senior secured debt, and most of the ratings are lower than investment grade. Therefore, the borrower's ability to repay is at risk and is regarded as highly speculative.

Fixed income "new favorite" BLF returns, due to poor bond yields?

According to a research report by Bank of America on January 29, bank loan funds had the largest three-week inflow of funds since 2017, reaching a total of 2.5 billion U.S. dollars.

At the same time, investment-grade bond yields have also fallen to historical lows, and investors have been withdrawing funds from high-yield bond funds. For example, the previously popular iShares iBoxx $ High Yield Corporate Bond ETF (HYG) has a current yield of 3.63%, while The Invesco Senior Loan ETF (BKLN) has a yield of only 2.80%, which is of course lower risk.

According to the data, HYG's return so far this year has fallen by 0.31%, while BKLN's return so far this year is 0.29%. In comparison, the returns of some BLF funds have risen from 2% to 8%.

Moreover, it should be noted that in the company’s capital structure, loans are prioritized over bonds, so when the company has funding problems, loans will be repaid with priority. Most loans also use floating interest rates, usually 90 days Libor and other short-term benchmark interest rates are linked.

On the other hand, the yield of long-term bonds has also risen sharply from the low in 2020, and the yield of 10-year US Treasury bonds has almost doubled to 1.10%. Given that bond prices and yields are inversely proportional, an increase in yields also means a fall in prices.

Another point to pay attention to is that for closed-end funds (CEFs, Closed-end funds) like BLF, investors need to understand that when fund promoters set up funds, they limit the total issuance of fund units. After the total amount is raised, the fund is declared established and closed, and no new investment will be accepted for a certain period of time. The circulation of fund units adopts the method of listing on the stock exchange. Investors must conduct bidding transactions on the secondary market through securities brokers when buying and selling fund units in the future. At this time, when investors buy into the fund at a 10% discount, the margin of safety is correspondingly increased, and when the price is narrowed, it also provides the potential for price appreciation.

Sangeeta Marfatia, senior CEFs strategist at UBS, said in a recent report that the discount rate of bank loan funds as CEF is the highest among such funds, with an average of 9%, which is lower than the average of 12% a year or two ago. Discount rate.

Moreover, CEFs do not need to meet redemption requirements, which makes them more suitable for holding relatively illiquid assets such as loans.

Pay attention to the default and leverage risks of BLF

Many investors may not be familiar with bank loan funds (BLF). The first thing to keep in mind is that the risks of this type of fund are relatively high. The risk of this type of fund can be understood as follows:

In recent years, loans that dominate most bank loan portfolios have expanded to lower-quality borrowers, some of which are even troubled borrowers or cyclical industry players. Secondly, compared with ordinary bond funds, Most BLF rates are also relatively high. In addition, some people use investment leverage to increase returns while also amplifying risks.

For example, a fund with 100 million U.S. dollars in assets uses these assets to invest in securities with a return rate of 10% for a certain period of time. In addition, it also borrows 25 million U.S. dollars to invest in this security. 10% profit return. So, in the end, the fund’s return is $12.5 million, which is 10% of the $125 million, but when your stock drops by 10%, you lose not just 10%, but 12.5%.

Although bank loan funds are less sensitive to changes in interest rates than many bond funds, this does not mean that they will not lose money. In fact, during the financial crisis, bank loan funds were the worst-performing fixed income category in 2008, with an overall loss of 29.7%. What investors need to understand is that in addition to concerns about borrowers’ ability to repay, bank loan funds themselves also suffered heavy losses that year, because some loan owners (especially hedge funds) were forced to A large number of shares were redeemed.

When investors are worried about rising interest rates, the market's demand for bank loan funds tends to soar. The loan yield fluctuates with interest rates, which helps to alleviate the impact of interest rate changes on the fund's net asset value.

to sum up

Compared with the game station mania in the market, buying bank loan funds (BLF) with funds can be said to be a completely opposite behavior. For investors, seeking relatively high returns with limited risks from reasonably undervalued assets is There is nothing wrong with it.

However, investors still have to pay attention to leverage risks. The bank loan fund listed last month has a yield of more than 6%, which is more than twice that of the unlevered BKLN, but if it declines in the opposite direction, the loss will be even greater.