'These record inflows into an ill-understood, more illiquid asset class present a danger to the value of loans if investors begin to reverse course and withdraw assets," writes Craig Sullivan of the $54.8B in inflows into bank loan funds YTD - more than triple the previous annual record in 2010 of $17.9B.
At the center of his argument is the perception that the floating-rate aspect of bank loans provides rate protection. These loans are typically of 5-9 year maturities, but the floating rate component is priced off of 90-day Libor. A rise in interest rates is of no benefit to the lender as long as the Fed holds short rates near zero. During the big move at the mid-long end of the curve in May and June, 90-day Libor actually fell 2 basis points - i.e., the price of the loan declined, but the yield went nowhere.
Also, most loans have Libor "floors," typically in the 150 basis points range. Good for lenders in that it provides some minimum yield, it also means - with 90-day Libor today at 26 bps - short rates will have to jump by 125 bps before the yield would move higher.
While the price movements of bank loans and high-yield bonds are fairly similar, high-yield index returns are ahead of bank loans by about 140 bps YTD, still carry higher yields, and offer call protection (bank loans typically offer none - when spreads drop they get refinanced). It's hard to make the case for choosing bank loans over high yield as long as short rates stay anchored near zero.