Actively managed, ultra-short duration floating-rate income strategy that invests primarily in privately syndicated, below investment grade senior secured corporate loans.
Portfolio review
Despite market volatility during 1Q24, the loan market remained resilient and outperformed both the high yield (HY) and investment grade bond markets. For the quarter, the Index returned 2.46%. The average bid price increased by 50 basis points (bp), finishing out the quarter at 96.73. Turning to the secondary market, lower-rated loans outperformed this quarter, as CCC rated loans posted strong gains of 5.17%, while single-B and double-B rated loans returned 2.45% and 2.00%, respectively.
Supply in the primary market surged, driven by a rally in secondary market prices and limited new issuance in the primary market, which created favorable conditions for opportunistic deals to launch. 1Q24 saw a robust repricing wave amounting to $151 billion. In addition, Leveraged commentary and data tracked $32.7 billion of extensions on outstanding loans in 1Q24. Overall, total institutional volume, excluding repricing and amendment activity, stood at $141 billion, with 61% tied to refinancings, totaling $86.1 billion.
CLO liability spread tightening in 1Q24 provided a much-needed boost to CLO issuance. This continues to be driven by further compression in AAA levels and continued demand from large money center banks in the United States and Japanese investors. The market continued to benefit from a significant number of CLO issuance, as the current year-to-date pace has surpassed expectations and is now tracking $48.8 billion across 106 new deals (up 45% from last year’s volume). There was a notable increase in inflows into retail loan funds, as $2.9 billion entered the retail fund space during the quarter.
There were six defaults in the Index during the quarter as the trailing 12-month default rate by principal amount decreased to 1.14% (from 1.53% in December).
On a NAV basis, Class I shares of the Fund outperformed the Index. The Fund’s primary relative contribution stemmed from the increased value of an existing equity position in Yak Mat (received as a result of a restructuring), as the company was acquired during the period. By ratings, selection in CCC rated loans contributed to the Fund’s performance. This was mainly driven by the overweight allocation to 24 Hour Fitness Worldwide, Inc., which posted improved financial performance for the full year 2023 and gave a positive outlook for 2024. From an industry perspective, the main drivers were hotels, restaurants and leisure, media, and IT services. Conversely, selection in health care providers and services dragged performance. Away from loan-level performance, the Fund’s modest exposure to HY bonds slightly impacted performance, as the HY bond market underperformed loans in 1Q24 (1.53% return for the Bloomberg U.S. Corporate High Yield Index).
Portfolio and positioning changes were both mostly minimal during the period. The number of individual names in the portfolio decreased from 394 to 350.
Current strategy and outlook
The macro outlook remains supportive, as U.S. growth is currently above trend coupled with a strong job market and rising real wages providing additional support to consumer spending. In addition, corporate balance sheets are generally in good shape, helping cushion any potential deceleration in growth. The markets will continue to monitor U.S. Federal Reserve policy, especially in light of the recently higher-than-expected inflation prints. While the timing of the first rate cut remains uncertain, the Fed’s data-dependent stance should provide some flexibility in adjusting policy measures in response to evolving economic conditions.
Looking ahead, we expect the technical backdrop to remain supportive in the loan market, as CLO issuance continues at a strong clip, while retail demand has firmed recently given attractive yields offered by the asset class. Fundamental factors have held up better than expected (mainly among stronger rated issuers) with generally stable demand and improving margins. Sectoral themes and sub sector secular developments remain prominent and worth paying close attention to. Although default activity remains muted, we expect trailing averages to gradually increase through the balance of the year, as higher rates further weigh on the weaker issuers with the stressed pockets of the market exhibiting increased activity in liability management exercises and distressed exchanges. Therefore, we generally maintain previously held cautious sectoral views and up-in-quality positioning.
Holdings Detail
Companies mentioned in this report-percentage of Fund investments, as of 3/31/2024: Yak Mat 1% and 24 Hour Fitness Worldwide 0.31%. 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subjected to change on a daily basis.
Key Takeaways
For the quarter, the Morningstar® LSTA ® US Leveraged Loan Index (the Index) returned 2.46%.
On a net asset value (NAV) basis, Class I shares of the Fund outperformed the Index.
Looking ahead, we expect the technical backdrop to remain supportive in the loan market, as collateralized loan obligations (CLO) issuance continues at a strong clip, while retail demand has firmed recently given attractive yields offered by the asset class.