Mutual fund companies this year are turning more attention to high- yield corporate loans and creating new customers for a market that was once the domain of commercial banks.
In recent weeks Van Kampen American Capital has launched its second loan fund and Fidelity Investments has been contacting banks about starting its first fund aimed at the corporate loan market.
An offering from Fidelity would bring 1997 launchings of such funds to four, tying the 1989 full-year record, according to Lipper Analytical Services Inc. There are now 12 high-yield corporate funds on the market.
Van Kampen launched its Van Kampen American Capital Senior Income Trust through a $1.6 billion initial public offering June 24. Jeff Maillet, who manages Van Kampen's $7 billion-asset American Prime Rate Income Trust fund, has been tapped to lead the new fund.
Loan mutual funds are a growing, but still small, part of the loan market. Syndications topped $1.6 trillion in 1997, but loan funds reported assets of only $17.8 billion as of March 31.
Loan mutual funds are widely seen as an alternative to bond funds because they hedge against interest rates. Bond mutual funds are tied to a fixed interest rate, and many bond fund managers are now investing in loans to hedge against interest rate swings.
The interest by individual investors in loan funds is derived primarily from two sources: The fact that most returns on loans float with interest rates and the developing liquidity of loans, said Andrew Giullette, an analyst with Cerulli Associates Inc.
"They've been a big success, especially with offshore investors, like those in Latin America, who want to get high returns outside their own countries where there may be political instability," he said.
Though the creation of loan funds greatly lags that of more traditional equity and bond funds, Mr. Giullette said that is primarily because loan funds require more expertise to launch and run. Fund companies have responded by making the funds hybrids: They are traded like closed-end funds or securities but they allow quarterly "tender windows" in which investors can cash out their shares.
But as the secondary market for corporate loan paper blossoms, more fund companies are feeling confident about getting into the game, market participants say.
It was only in the early 1980s that loans began to trade in a secondary market not unlike bonds. Now, almost all of the top lenders and institutional investors run secondary trading desks for corporate loan paper. And several small start-ups do such work independently of underwriting loans.
The newfound liquidity in corporate loans has been beneficial to funds because mutual fund investors like the ability to shift assets from one fund to another to catch waves. That requires fund managers to sell loan paper quickly to meet their investors' requests.
Bruce W. Ling, head of syndicated finance at Credit Suisse First Boston, said the rising popularity of loan funds has benefited the market as well by creating new buyers for paper, primarily high-yield loans priced at 2% above the London interbank offered rate.
So strong has the institutional market become that when Credit Suisse introduced an $850 million leveraged loan to Ispat International NV last week, $700 million was structured for institutional investors.
Those investors are not only made up of mutual funds but insurance companies, consolidated loan obligations, and hedge funds.
"These funds are immensely important to our market," Mr. Ling said. "Institutional investors are less focused on maturity" and tend to use a buy-and-hold strategy.