Liquidity in Leveraged Loans

Many investors consider liquidity to be the most opaque element of leveraged loans, but is that a fair assessment given the current landscape? Ted Basta of the LSTA and Invesco PowerShares’ James Meyers join S&P DJI’s Jason Giordano to discuss recent regulatory changes and the depth of liquidity in primary and secondary markets for senior loans.

Many investors consider liquidity to be the most opaque element of leveraged loans but is that a fair assessment given the current landscape hello i’m jason giordano and we’re back with ted basta senior vice-president of the loan syndication trading association and james myers head fixed income strategist for power shares to take a closer look at liquidity and

Senior loans ted james thanks for joining us again pleasure to be here happy to join so ted can you provide us with an update on the regulatory initiatives and maybe discuss what impact they’ve had on the asset class sure i think the the most applicable conversation to have today is in terms of the new scc liquidity management rule that was just recently put

Out although the rule itself doesn’t go live until december 18 we’ve obviously been having a number of different conversations with managers this rule applies to all open end mutual funds including obviously loan open end mutual funds and when the sec looked at liquidity really what they’re trying to assess is a funds ability to meet redemptions and when we speak

About liquidity we have to break up liquidity into two different categories we have trade liquidity the ability to buy and sell at a fair price and then what we have what we refer to as settlement liquidity actually getting that money in house loans obviously aren’t securities so not all the time there’s a loan settle within t3 and i think that was an issue for

The sec but in actuality though the manages of open as well as closed that mutual funds i’ve been studying their liquidity risk management programs for 25 years now back to the rule for a second though so the sec had asked to bucket liquidity by four different buckets one being the most liquid four being the least liquid we believe right now that loan should be in

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The third bucket quote-unquote less liquid and again when we talk about liquidity from a trading settlement standpoint i think that refers back to the fact that loans don’t settle within t3 again because they’re not a security where as trade liquidity is as good or even better in times of duress than we see in the high-yield bond mm so that the term less liquid

Could be concerning to some investors can you talk about the depth of liquidity that you’re seeing in both the primary and secondary markets sure i’d actually say there’s a bit more liquidity than we need in the markets right now when you look at the secondary market the average loan is trading above its intrinsic value or above a hundred cents on the dollar

Tremendous amount of liquidity 2016 our training volumes for the year was almost six hundred billion dollars on a day-to-day basis there’s more than 400 individual issues trading for about in total about three billion dollars per day if we look at just january of this year we saw in excess of 60 billion dollars trading in the secondary that was a two-year high

So again you know given what’s going on in the world right now i think liquidity looks pretty darn good in the secondary loan market james can you describe the operational leverage and structural efficiency of an etf and how they may provide institutional investors with enhanced liquidity sure i think it’s important to think about the fixed income market and how

The trading differentiates from the equity market so the fixed income market is largely an over-the-counter market whereby buyers and sellers are paired either through electronic communications or through calls or through a limited platform that compares with equities which are much broader and more global and where almost all the trading is automated so given

The structural less efficiency of the fixed income market the etf structure lends a lot of important benefits to institutional investors who are looking to to invest in fixed income so first and foremost it addresses the intraday liquidity with an etf you’re able to buy and sell throughout the day that is compared to fixed income where a bond might not trade on

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A given day so you’re getting that intraday liquidity that you also cannot possibly get in a fund where you get marked at the end of the day secondly it’s offloading the transactional risk as an institutional investor rather than having to buy and sell in the secondary markets you’re instead buying an etf with a broad basket exposure to that fixed income sector

And essentially offloading the trend action or risk to the etf manager who has established relationships who has the interaction with the sell-side and can manage it just like you would be managing a separately managed account but in a fixed-income etf wrapper and then thirdly the ability to buy and sell the etf where a lot of the trading in a particular fixed

Income etf strategy is done in the actual shares rather than even having to go into the cash markets to trade in secondary fixed income and some of the products out there including the power shares lineup almost 80 or 90% of the trading is done in the underlying shares rather than in the secondary markets and that’s inclusive of the loan product that we have

So we think there are very important benefits of the etf wrapper wow that’s great and and finally can you explain where a senior loan etf may fit into an institutional mandate sure so i think there are three primary slots where loans add value and as we mentioned in prior videos that ted mentioned loans have a very short duration because they’re a floating rate

Instrument and since their coupon adjusts and they have low duration in a rising rate environment as many expect for this year they add a lot of value through correlation benefits both to fixed rate fixed income and to equities and alternatives so given that framework we see institutions utilizing a couple different applications first and foremost if you are

Looking to structure a core plus portfolio where you’re looking to diversify away from the core which we define as treasuries and mortgages primarily then loans fit in combination with emerging markets with preferreds with high-yield debt as a diversifier to hopefully achieve stronger risk adjusted returns and again in a rising interest rate environment where

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A duration risk is is key to monitor secondly we’re seeing institutional investors utilizing a floating rate bucket within their asset allocation as a distinct asset class and that’s important as the asset class improves in terms of availability of a fixed income et options and floating rate as the market improves so that again with the correlation benefits is

Something that is making it a distinct asset class within an asset allocation framework and then thirdly for institutional investors who might be looking to reduce their high-yield exposure and might look at loans as an alternative we track the relative value in the yield differential between the two asset classes right now you’re getting a little bit over 1%

On average to go from loans into bonds and given the fact that loans have that rising libor benefit we talked about the low duration and historically have lower defaults and higher recovery values because of their seniority in the capital structure for institutions looking to do that trade right now is probably a good time from a relative valuation standpoint

Yeah i’d actually at one point to that something that’s very important when you think about adding loans to the asset mix is the lower level of volatility that you can obtain by heading loads to a portfolio today loan returns are actually less volatile than not only the high-yield bonds that are in the market but also high grade bonds as well as treasuries so

From from an overall volatility perspective you’re actually lowering that level of volatility of return for the portfolio ted james thank you both for joining us today and thanks for providing your insights there’s a pleasure to be here today happy to join for more information on our fixed income indices and to watch our first video what’s driving senior loan

Performance where we discussed how demand for leveraged loans continues to persist visit sp dji calm you you

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Liquidity in Leveraged Loans By S\u0026P Dow Jones Indices Channel