Boston - Eaton Vance and its affiliates seek to actively capitalize on opportunities presented by volatile investor sentiment, while ensuring that the portfolio risk profile remains appropriate for the specific strategy. The following are excerpts from a recent conversation with Andrew Sveen, CFA, and Craig P. Russ, Portfolio Managers, Co-Directors of Floating-Rate Loans for Eaton Vance Management.
What we are seeing: Following a month of sharply rising loan prices, the welcome rebound in the senior loan market is taking a breather at present. To recap the round-trip experience to date, the average price of the S&P/LSTA Leveraged Loan Index traded in the 96 context as recently as mid-February, plummeted to a low around 76 by the third week of the now-historic March and has since rallied to its current resting point around 86 — and here it has hovered for the last week or so. Though the market is roundly "halfway back," prices today still rank among the lowest in the long history of the asset class.
Rarely are rebounds a straight line — in this or any asset class — and we certainly didn't expect one here in the current environment. Things are happening quickly on the one hand: Downgrades have come fast and furious; prices have rallied sharply and quickly. Yet on the other hand, slower moving developments require waiting: When will states and businesses reopen? First-quarter earnings and the latest growth number are almost meaningless, but when will the picture clear for the back half of the year? To what extent will the Fed's new lending programs benefit issuers?
In short, we think the market is catching its collective breath at the moment, as there's much to take in and the "easy money" has now been made. To be sure, all rating tiers sold off indiscriminately and to similar levels at the nadir, setting up the high quality, large and liquid issuers for the earliest and largest rebounds. This has in fact played out, with BBs in the index (representing around 20% of loans outstanding) priced at 92 on average, and many of these are now back to the middle to high 90s at present. Meanwhile, the B-rated belly of the market (almost 60% of loans outstanding) is priced at 87 on average, with significant dispersion around this figure.
Market participants continue to sort these out and, as they do, there are other factors at play. New issuance has returned, not in a massive way but enough to weigh on the supply/demand balance on the margin. And according to ICI, mutual fund flows have edged from positive flows two weeks ago to now (ever so modestly) negative again. Larger cash stores in funds have been allocated at this stage, while some dry powder remains for opportunistic buying and/or redemptions.
Taken together, not a lot of net new buying... a little bit of net new supply... and myriad factors to weigh for the economy, sectors, issuers, etc. And so here loans sit at 86 while the market digests.
What we are doing: As always, our analysts are squarely focused on their credits. We continue to stress test our portfolio companies, assessing liquidity both in the near term and further out. We remain in touch with issuer management, and we're keeping our credit assessments fresh as we digest first-quarter business results and probable business impacts (and again, liquidity) looking ahead. We're paying special attention to the re-underwriting of the most direct-hit sectors in this environment: travel-related, leisure and retailers. In the meantime, our portfolio managers remain focused on value determination, and our traders are executing orders in line with our efforts to strike the right balance between offense and defense, a theme that's the very heart of our ongoing effort to optimize risk and return in our loan strategies.
What we are watching: Dislocations like this indeed provide ample opportunity, but we're proceeding with a measured approach as we always do. The first half of the rally was quick and relatively easy. We think the balance will be more of a grind. There will continue to be much to watch in the weeks ahead. At the intersection of today's low prices are not only a wave of credit downgrades unfolding by the day, but also the Federal Reserve's many support programs (basically, "whatever it takes") and the growing number of governors beginning to talk cautiously but optimistically about the reopening of the economy, with May being a key month to watch these developments. Levels of distress have declined sharply in the last few weeks, and this has been good to see. The easy pickings will be harder to come by as the market rebounds, but healthy opportunity remains for now.
Final word: We believe that an emphasis on quality and diversification never goes out of style, and this remains our focus. A recent pause in the rally notwithstanding, we continue to see significant value in this asset class. Upside potential remains, but it won't be a straight line.