AI Sparks Fear in Retail Funds

Investor anxiety is mounting as fears of rising defaults migrate from the leveraged loan market to retail funds that purchase these debts. Money managers, who bundle leveraged loans into collateralized loan obligations (CLOs), are facing scrutiny as the riskiest parts of CLOs, known as CLO equity, see dividends cut. This downturn is exacerbated by concerns over AI's potential to disrupt software companies, which constitute a significant portion of leveraged loans.

Share prices for several closed-end funds have plummeted to all-time lows, illustrating the broader unease in the $1.3 trillion CLO market. While publicly listed CLO equity funds represent a small fraction of the market, their struggles highlight the complex transfer of risks to various investors, including retail holders. Some funds have already reduced their monthly shareholder distributions in response to the evolving market landscape.

Despite the current volatility, some experts suggest that this period could present a buying opportunity for CLO equity funds. By acquiring debt at a discount, investment managers may be able to boost long-term returns. However, other market forces, such as a lack of new leveraged loans and the prevalence of "captive" funds, continue to pressure investor profits and dividend payouts.