Actively managed, ultra-short duration floating-rate income strategy that invests primarily in privately syndicated, below investment grade senior secured corporate loans.
- Broad market sentiment stabilized in 4Q22, helping buoy performance in the loan market and other risk assets, as the Morningstar® LSTA ® US Leveraged Loan Index (the Index) gained 2.74% during the period.
- The Class I shares of the Fund underperformed the Index as the Fund was primarily impacted by selection in CCC and single-B rated loans, and hotels, restaurants and leisure, as well as trading companies and distributors at the sector level.
- Looking ahead, we believe many of the issues that confronted the leveraged credit markets in 2022 will persist into 2023, though we hope to see resolution of certain issues as the credit cycle matures.
Broad market sentiment stabilized in 4Q22, helping buoy performance in the loan market and other risk assets, as the Index gained 2.74% during the period. The Index bid price increased by 24 basis points (bp) to 92.44, primarily attributable to the firmer trading levels in the first two months of the quarter, as December experienced some modest price declines. On a relative basis, loans trailed equities, investment grade and high yield (HY) bonds in December but notably outperformed for the full-year period given rising rate hedge. In 2022, loans were only down –0.6%, as compared to more than double digit losses experienced in fixed rate bonds (–15.7% and –11.1%, respectively for Morningstar US Corporate Bond Index and Morningstar US High-Yield Bond TR USD Index).
In line with the prior two quarters, a continued flight to quality theme was evident, with returns for BB, single-B, and CCC rated loans coming in at 3.93%, 2.80% and –2.05%, respectively. The dislocation amongst different ratings buckets and liquidity profiles remained intact, with better-rated and liquid areas holding better relative to lower quality and illiquid names. On a full-year basis, double-B, single-B and CCC rated posted returns of 2.99%, –1.07% and –12%, respectively.
New loan supply remained limited, although increased to $35.7 billion (from $22.2 billion in 3Q22). Refencing activity was the main driver of issuance, as higher-rated issuers looked to extend maturities. Total volume for the year amounted to $225 billion, which is below the record $615 billion issued in 2021. On the other hand, investor demand decreased as collateralized loan obligation (CLO) issuance slowed and retail fund flows remained firmly negative. CLO formation decreased to $22 billion given challenging liability backdrop and weaker demand from Japanese banks. Despite the lighter quarter, the full-year tally was the second most on record at $129 billion. Meanwhile, retail loan funds experienced $14 billion redemptions during the quarter, bringing 2022 net outflow activity to $13.5 billion.
On a NAV basis, Class I shares of the Fund underperformed the Index (which reflects no cash allocation or fee expenses). By ratings, the Fund was negatively impacted by selection and overweight to CCC rated loans and selection in B rated loans. From an industry perspective, selection in the following sectors detracted from relative returns: hotels, restaurants and leisure, trading companies and distributors, media and software. When looking at individual issuers, negative outliers included owning a non-benchmark to 24 Hour Fitness Worldwide, Inc. and overweights to Yak Mat, Diamond Sports Group, LLC, and Telesat Canada. 24 Hour Fitness Worldwide, Inc, on no news, moved lower based on a small handful of secondary trades that pushed the quoted level in the name down. Meanwhile, Yak Mat, Diamond Sports Group, LLC. and Telesat Canada remained under pressure given weak earnings and challenging liquidity. In contrast, the Fund was helped by the selection in BB rated loans and the avoidance of a few loans within the D-rated cohort. The primary industry-level benefit stemmed from selection and overweight to specialty retail, followed by selection in chemicals. The top issuer-level contributor was the avoidance of Cineworld. Away from loan-level performance, the Fund’s modest exposure to HY bonds had a positive impact on performance, given the outperformance of the HY bond market in 4Q22 relative to loans (4.17% return for the Bloomberg U.S. Corporate High Yield Index).
Portfolio and positioning changes were both mostly minimal during the period. The portfolio reduced individual names from 391 to 356 in order to meet redemptions, while the average spread level of the Fund decreased modestly to 386 bp (versus 393 bp in the prior quarter). In terms of positioning, we made no fundamental changes during the period. Elsewhere, there were no defaults experienced in the Fund, nor in the Index.
Current strategy and outlook
Looking ahead, we believe many of the issues that confronted the leveraged credit markets in 2022 will persist into 2023, though we hope to see resolution of certain issues as the credit cycle matures. Notable macro themes for 2023 include slower global growth with heightened recession potential, deceleration from peak inflation levels, less aggressive and less synchronous central bank policies, lower rate volatility and continuing geopolitical risks. While macro news will have an impact on technical factors, fundamental factors likely will be a bigger story. A weaker earnings environment raises the prospects of more downgrades and defaults and continued ratings and sector dispersion among weaker credit profiles, particularly among loans. Some of the downside potential already is reflected in current valuations, e.g., loan prices in the low 90s. Considering high starting all-in yields, we believe loans still offer fairly attractive relative value, but given the late-cycle backdrop, acknowledge the need for careful credit selection and monitoring.
Companies mentioned in this report – percentage of Fund investments, as of 12/31/22: 24 Hour Fitness Worldwide, Inc. 0.45%, Yak Mat 0.60%, Diamond Sports Group, LLC 0.24%, Telesat Canada 0.45% and Cineworld 0%; 0% indicates that the security is no longer in the portfolio. Portfolio holdings are subject to change on a daily basis.
Voya Floating Rate Fund Quarterly Commentary - 4Q22