Van Kampen Opts for Third-Party Pricing
February 21, 2000
Valuation by a third-party of the underlying assets in corporate loan funds received a boost in early February when one of the largest managers of that type of fund announced it was outsourcing the pricing of the assets in three of its loan funds.
Van Kampen of Chicago, which runs the industry's largest loan fund, the Prime Rate Fund with $8 billion in assets, as well as two others - the Senior Floating Rate fund with $1.7 billion in assets and the Senior Income Trust fund with $1.8 billion - agreed to have the loans in those funds priced by Loan Pricing Corp., the leading provider of loan-pricing services for these kinds of funds.
"The market has just reached a stage where, to some degree, it is more reliable to use third party indications than to use our own," said Howard Tiffen, a senior vice president at Van Kampen who manages the portfolios of the three Van Kampen senior loan funds.
Before last year, when Loan Pricing Corp. of New York and the Loan Syndication Trading Association launched their pricing service, there was no objective standard for pegging the value of a fund's loans on the secondary market on a daily basis, said Tiffen.
Prior to the introduction of the service offered by Loan Pricing Corp., the value of the senior loans in a fund's portfolio were calculated internally. That could lead to questionable valuations.
"What our service does is give investors a greater deal of confidence in the objectivity of how the prices were derived," said Jeff Reichert, senior vice president for Loan Pricing Corp.
Third-party pricing of senior syndicated corporate loans is seen as a significant development in growing the secondary market for the loans. The larger the secondary market, the more funds will invest in these loans.
That secondary market has been growing in recent years, but at $60 million, it is still a very small part of the $1 trillion market for these types of corporate loans.
"The secondary market for loans has exploded," said John Cardillo, product manager for the Oppenheimer High Income Fund. "Secondary market trading is still nothing like it would be for stocks or even high-yield bonds, but it's getting there."
"This is a much more liquid market now, so there is much better pricing information available to arrive at indicative market values for these portfolios."
A sign of the growth in market liquidity can be seen in the demand for Loan Pricing's services, which has grown from one fund when the service was launched to around 100 funds today.
The risks and returns for these loans are much more transparent to market participants today, Reichert said.
"That transparency has made these loans as an asset class attract a whole new participant in the market-institutional investors," he said. And, it has induced deal-makers to structure their deals in the primary market to meet the needs of those investors, which include a liquid secondary market.
Also contributing to the growth of the market is the dwindling inclination of financial institutions to hold on to medium-term corporate debt.
"Corporations are less reliant today on banks for their medium-term, floating-rate credit needs than they used to be," Tiffen said. "Since banks have such tremendous demands on their very scarce capital bases, they prefer to arrange these loans and sell them off to institutions like ours."
The attractiveness of these loans is also becoming more apparent to investors, according to Cardillo. One attraction is that their returns do not correlate closely with other investment vehicles such as stocks, treasuries or high-yield bonds.
"These loans pay a floating-rate of interest, so they're pretty much Teflon when it comes to changing interest rates," Cardillo said. "They're not really affected by interest-rate risk."
Although the loans are made to below investment-grade companies, they are not as risky investments as high-yield bonds, Cardillo said. One reason is that the loans are at the top of the pyramid of corporate debt. If a company goes bankrupt, loan creditors get paid before shareholders or high-yield bondholders. In addition, many of the loans are secured with collateral, which means there is an asset creditors can sell to recoup their money should the company default on the loan. Moreover, covenants can be placed on the loans to prevent a company from engaging in risky business practices after they receive the loan.
"Adding these loans to a portfolio can make a lot of sense to an investor, not only because of the interest rate protections from these loans' floating income schemes, but because this is a safer way to invest in a below investment-grade company than investing in their equity or high-yield bonds," Carddillo said.