As hedge funds continue to play an increasingly bigger role in the leveraged loan market, investors are questioning whether they will stay in the market or if they are just hot money investment funds capriciously seeking high, short-term yields. The question is important as the funds have become the third largest investor base in the market.
"I think hot money is a popular term for the incremental dollar that is looking for yield and willing to take some flexibility in structure," noted Pete Vaky, managing director and head of syndicated finance with SunTrust Robinson Humphrey Capital Markets. "In everyone's minds that tends to be the hedge funds and loan funds that have to fill investment quotas."
The question of hot money depends on the investor's strategy, noted Anthony Clemente, global partner with INVESCO. "If it's a strategy that relates to relative values and the relative value happens to exist in loans, then you are going to see more volume or demand," he explained. "If it's a strategy where the relative value is better elsewhere, then you'll have outflows." Vaky agrees. "These guys are the ultimate relative-value buyers," he said.
Hedge funds are the third largest institutional investor after collateralized loan obligations and prime-rate funds, a banker said. Vaky said fund usage or number of funds around will run parallel to an easing in some of the credit structures such as tenor and leverage and will probably correspond to a decrease in spread.
A portfolio manager at a hedge fund said hedge funds will move when the time is right. "New players really trying to look for yield and what is perceived to be the safest investment--they are secured loans," he said. Right now, there is a lot of money chasing few returns, he added. "The leveraged loans that were issued three months ago are now coming 100 basis points tighter than today," he said. "It's really reflective in pricing. Most of the deals are well oversubscribed and trade immediately to 101." Once the hedge funds leave the leveraged loan market, the tight spreads should ease up, he explained. "It's just a flow of the market will be taken out. New deals will be priced further and further back. Instead of 225 it will be back to L+300. It will clear the market in that there are still a lot of other funds involved in leveraged loans," he added.
Vaky believes hedge funds will stay in the leveraged loan market, but will not remain as aggressive as they currently are. Clemente agrees the hedge funds are not leaving the market. "I do think hedge funds are here to stay, using loans as one of the arrows in their quiver," he said. "It's a great way to go long credit." The hedge fund portfolio manager believes the hedge funds will stay for the time-being and all the funds will not pull out at the same time. "I think usually as with anything, outflows can happen and pricing can back up for no reason," he said.
