Credit "Death Spiral" Accelerates As Loan ETF Sees Record Outflow, Primary Market Freezes

One week after even the IMF joined the chorus of warnings sounding the alarm over the unconstrained, unregulated growth of leveraged loans, and which as of November included the Fed, BIS, JPMorgan, Guggenheim, Jeff Gundlach, Howard Marks and countless others, we reported that investors had finally also joined the bandwagon and are now fleeing an ETF tracking an index of low-grade debt as credit spreads blow out and cracks appeared across virtually all credit products.

Specifically, we noted that not only had the $6.4 billion Invesco BKLN Senior Loan ETF seen seven straight days of outflows to close out November, with investors pulling $129 million in one day alone and reducing the fund’s assets by 2% to the lowest level in more than two years, but over 800 million has been pulled in last current month, the biggest monthly outflow ever as investors are packing it in.

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Fast forward to today, when another major loan ETF, the Blackstone $2.9BN leverage-loan ETF, SRLN, just suffered its largest ever one-day outflow since its 2013 inception.

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Year to date, the shares of this ETF backed by the risky debt have dropped 2.6%, hitting their lowest level since February 2016; the ETF's underlying benchmark, the S&P/LSTA Leveraged Loan Index, has also been hit recently and is down 2.3% YTD, effectively wiping out all the cash interest carry generated YTD and then some.

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"The price action in the ETF hasn’t warranted investors to justify keeping it on to collect the monthly coupon it pays," said Mohit Bajaj, director of exchange-traded funds at WallachBeth Capital. "The risk/reward hasn’t been there compared to short-term treasury products like JPST", he added, referring to the $4.2 billion JPMorgan Ultra-Short Income ETF, which hasn’t seen a daily outflow since April 9.

Couletsis pointed to widening credit spreads and the fact that loan ETFs have floating-rate underlying instruments, assets that become less attractive than fixed-rate ones should the Fed skip its March rate hike, which after Powell's latest dovish turn and today's weak payrolls may - or may not - happen.

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Gary Anderson 1 week ago Contributor's comment

It is interesting that in 2007-2008 the failure of floating rates brought on the Great Recession as the banks bet on them but they soared and exceeded fixed rates. And now floating rates are seen as risky again.