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Investor Perspective: Who’s Up, Who’s Down

July 27, 2017 - Lately there has been much discussion about excess demand from investors. But what, exactly, is the state of investors? Below, we recap recent news about CLOs, loan mutual funds and direct lenders. 

To kick it off, ThomsonReuters LPC charted the size and growth of the CLO/Loan Mutual Fund complex. In January 2013, the combined holdings of U.S. CLOs and loan mutual funds totaled less than $400 billion; today, it is more than $600 billion. At nearly $460 billion outstanding, CLOs comprise both the majority of the complex and most of the growth.  At $58 billion, new U.S. CLO formation has been stronger than anticipated this year, albeit behind the pace of 2014 and 2015. But older CLOs are shrinking rapidly as well. In turn, CLO outstandings are up only 3% - $13 billion – year to date. 

While CLOs, which are long-term vehicles, have generally demonstrated slow but steady growth since 2013, loan mutual fund AUM has waxed and waned and waxed again. This week, LCD asks whether, after nearly a year of heady gains, it’s time for another wane. Loan mutual fund AUM hit $154 billion in June, up from $134 billion at the beginning of the year. However, inflows into loan mutual funds and ETFs totaled a meager $153 million (per Lipper weekly figures), as compared to an average $2.8 billion during each of the previous five months. 

While CLOs and loan mutual funds hold a whopping $600 billion of loans, it has been a rising question whether CLOs and loan mutual funds (and, for that matter, the syndicated loan market) would be disintermediated by direct lenders. Perhaps not, Reuters suggests, in an article titled “Direct lending funds’ fading all-weather appeal”. The headline gives away the thesis of the piece (which, it should be noted, appears mostly focused on lower middle market direct lenders). Data tracker Prequin points out that there has been remarkable growth in the direct lending segment since 2009: Just 30 direct lending funds launched between 2004 and 2008; since then, another 200 have opened. Meanwhile, funds’ assets have increased from $33 billion in 2008 to $100 billion in June 2016, Prequin data shows. But, are we past peak?  A Reuters survey suggests that the flood of direct lending money is driving a deterioration in lending standards and returns, and also may be creating a mismatch between the duration of the assets and the funds’ lock-up periods. 

That last point may be worth considering. Larger managers such as Golub and Monroe Capital require investors to commit capital for three or more years, Reuters reports. However, according to a review by eVestment of 71 direct lending or asset based funds, two-thirds of funds have a lock-up period of a year or less. (To be fair, many of these funds do have the ability to freeze funds, Reuters adds.) Still, that brings us to the point that started this piece: CLO holdings have enjoyed a slow and steady (and stable) rise precisely because they are match-funded, long-term investors.

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