London/Paris: Fitch Ratings estimates that open-ended Europe-domiciled loan funds have had strong average annual growth of 50%-60%, albeit from a low base, over the last five years. In a report published today Fitch estimates total assets of just EUR40bn across all European open-ended funds at end-June 2016, with most investing in US and European leveraged loans rather than having a pure European focus.
Loan fund assets in the US are substantially greater than in Europe, at around USD110bn as of end-June 2016. This is a function of size – the US loan market is roughly four times larger than Europe’s – and also because loans are not eligible assets under Europe’s UCITS fund regulation, which precludes retail investment. Loan funds in the US are actively sold to retail as well as institutional investors.
Fitch estimates that collectively the share of new issuance acquired by loan funds and separately managed accounts in Europe is now only marginally smaller than that of CLOs. This makes funds and mandates collectively a significant institutional loan investor group and reflects a shift in the investor base in the European loan market away from banks to institutional investors and among the institutional investors to funds and mandates along with the CLOs.
European CLOs and loan funds broadly invest in the same sectors in roughly the same proportions. However, some important differences exist. European loan funds can, and do, have greater maximum issuer and industry exposures. They are also more able to invest in non-base-currency exposures, which may support diversification while introducing foreign-exchange risk. European CLOs primarily invest in euro-denominated leveraged loans. Lastly, they can also diversify into other asset classes such as infrastructure or commercial property debt or run larger bond exposures than CLOs.
Redemption terms on open-ended European loan funds are typically longer than for fixed-income funds. Most loan funds offer monthly liquidity with a notice period, whereas most bond funds offer daily liquidity with T+3 settlement. This difference recognises that loans can be less liquid than bonds, but it is far from certain that funds could sustain liquidity in the event of severe market stress, especially given potentially long loan settlement times in Europe.
The report, ‘European Leveraged Loan Funds: High Growth Reflects Shifting Loan Investor Base’, is available on www.fitchratings.com.