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: The senior loan market renewed its footing in the waning days of March, capping a tumultuous month with a rebound in technical conditions that shot deeply discounted loan prices higher. The S&P/LSTA Leveraged Loan Index bottomed at an average price of 76.2 as recently as March 23, leaping almost 9% in the final week of the quarter, to 82.9 on March 31. If not for the late-period rally, March 2020 would have recorded the loan market's "worst month ever." In the end, it settled for second place at -12.4%, outdone only by the -13.2% plunge in October 2008. For context, consider that investors assigned an average loan price of 95.2 just a month ago. What's been so interesting to see is just how quickly the panicked inquiries ("what's wrong?") have given way to the opportunistic ones ("what's the best way to play this?"). The sheer speed and depth of the drop is likely why — and the subsequent shift in flows, and now prices, suggests this remains underway.
What we are doing: As the sell-off unfolded, we focused first and foremost on portfolio (and flows) management, assuring the integrity of our investment process and redemption readiness, and of course our comfort with portfolio exposures. The market remained open and secondary trading volumes almost surely set records. (It will take time for the market data to know for sure.) We also remained as focused as ever on our portfolio credits, looking for new ways to reanalyze our sector exposures and stress-test our issuers. We've re-underwritten the limited share of credits within the most severely impacted areas with the greatest immediate virus fallout: travel, hospitality, theaters and restaurants. We're culling through and sanity checking ratings downgrades, as the agencies are now playing catch-up with the situation, and we're assessing potential return scenarios under various default/recovery assumptions. However we run the numbers, it takes far-fetched inputs to justify today's price levels.
What we are watching: No one can call a bottom, and we certainly won't. For now it appears behind us, and it's fair to say that some of the typical conditions for a bottom have indeed showcased themselves at this stage, albeit (important caveat) only over the past week. Assets in retail loan funds are approaching a cycle low. Redemptions have slowed markedly, with fits and starts of positive inflows. We know there's a core base of strategic holders underneath and it feels like the market is approaching that base at these levels. Floodgate redemptions were the Achilles' heel for loans in the opening weeks of March, but retail funds now account for a little over 5% of loan outstandings. Their smaller stick and the absence of big outflows is what's sending prices higher. Other green shoots we see on the market's technical condition: Discounts on closed-end loan funds have narrowed significantly (these often lead), while the so-called 100 index of the largest/most liquid loans has outperformed over the last week (these "flow names" tend to lead also). Meanwhile, distressed debt funds have been busy. Take these latter points as mere tea-leaf reading, but we think they're nonetheless positive.
Final word: It may be choppy in the near term and the nascent recovery in loan prices may experience retests ahead. But it's clear to us that the market's technical pressure has overshot the fundamental value inherent in this asset class. Price is what you pay. Value is what you receive. Senior loans at current levels suggest one of the best values in this market's long history. Loans were cheaper only last week, and in 2008/2009. It may feel scary now. The lows of past sell-offs did as well.