Invesco takes risk as investor in distressed debt
When a unit of a Texas power giant filed for bankruptcy this year, investors did not go looking for bargains. Because the company was saddled with $40 billion in debt from a boom-era buyout in 2007, the virtual “buyer beware” tag on its leveraged loans kept even the most brazen risk-seekers at bay.
With the exception, that is, of a $6 billion exchange-traded fund. The troubled loans of the Texas utility — Texas Competitive Electric, a subsidiary of Energy Future Holdings — now represent one of the Invesco fund’s largest positions.
Exchange-traded funds, or ETFs, are bundled pools of assets, ranging from stocks and bonds to currencies and derivatives that are bought and sold on equity markets by large and small investors alike. This ability to gain entry to some of the more arcane corners of Wall Street, and to exit from them immediately, has made ETFs wildly popular for retail investors. In the last decade, ETF assets have exploded to $2.5 trillion from less than $500 billion.
But this growth has also raised concerns among regulators, who worry that too many of these assets have been accumulated in hard-to-sell investments like junk bonds, emerging-market debt and, farthest out on the risk frontier, leveraged loans.
In a report early this year, the International Monetary Fund highlighted the extent to which mutual funds, and ETFs in particular, had become overly exposed to these sectors. The fund warned that credit-driven ETFs might not be able to pay back investors in time, given how illiquid their investments were.
The Federal Reserve Bank of New York has also expressed a similar concern.
In this regard, Invesco’s senior loan fund is an outlier because leveraged loans, compared with emerging market debt and junk bonds, pose the greatest challenge in terms of matching sellers with buyers — especially now that investment banks carry fewer of these securities on their books for regulatory reasons.
Paul Britt, an analyst with ETF.com, says that few investments have longer settlement times than leveraged loans.
Moreover, given their reliance on sub-investment-grade loans, ETFs are exposed to any softening in the economy.
“BKLN has credit risk in spades,” he said, using the name of the Invesco fund’s market ticker. “And it has become a bit of a whipping boy in terms of this theme.”
It should not be a surprise that a product line called PowerShares — as Invesco’s suite of exchange-traded funds is called — will have a go-go investment orientation.
And while many of its ETFs are mainstream investments, from emerging markets to municipal bonds, Invesco has been more or less on its own in terms of its focus on leveraged loans.
It is hard to argue with the results so far: Over the last four years, few exchange-traded funds grew as rapidly as Invesco’s senior loan fund.
From its birth in March 2011, the fund soared past $7 billion in assets this year as yield-starved investors piled in en masse. Invesco’s senior loan fund represents about 90 percent of the ETF market for these types of securities, and overall, mutual funds oversee about $150 billion in leveraged loan assets.
This kind of asset growth has attracted the attention of the largest investment management firms in the business. The industry leader, BlackRock, which oversees close to $1 trillion in ETF assets, is betting on exchange-traded funds to drive the company’s profits in the years ahead.
Nevertheless, even BlackRock’s chief executive, Laurence Fink, has said that leveraged-loan ETFs are too risky for his liking.
Other top bond investors like Jeffrey Gundlach at DoubleLine have raised questions about leveragedloan funds and their capacity to raise sufficient cash to meet redemption demands.
In the asset management industry — where rival firms will pounce on one another at the slightest scent of blood — such sniping is par for the course.
Take BlackRock’s and DoubleLine’s recent and not very subtle bids to lure clients away from Pimco after the departure of its star portfolio manager, William Gross.
A spokesman for Invesco said the firm declined to comment on the fund and its investment strategy.
Aside from its holdings in Texas Competitive Electric, which accounts for 3.08 percent of the portfolio, the fund also has major exposures to other companies with weak balance sheets.
These include Caesars Entertainment, the casino company that is deep in talks with its lenders to restructure it’s nearly $24 billion debt load and stave off bankruptcy.
PowerShares owns several loans from the company, with an overall exposure of 3.3 percent.
Still, the fund invests in more than 100 companies, many of which are in better financial shape.
Analysts also say that because leveraged loans are secured by assets from the company, recovery rates can be high.
In its prospectus, PowerShares does not sugarcoat the risks, and Invesco points out that all the loans in its portfolio are below investment grade. That means that they have been issued by companies that already have large debt loads and are thus forced to borrow at high interest rates.
Invesco also says that as the credit conditions of these companies worsen, “secondary trading of that loan may decline for a period of time,” and that if the fund is forced to sell its securities during one of these dry periods, “it may not receive full value for these assets.”
Since August, spurred by concerns about their exposure to riskier debt instruments, investors have withdrawn close to $800 billion from the fund.
That represents the worst three-month period in outflows since the fund’s inception.
As Britt, the ETF analyst, points out, the fund has shown itself capable of meeting significant cash demands by investors during a fairly difficult market period.
But it is also true, he cautioned, that in terms of surviving a more extreme market collapse, the ETF has yet to be tested.