Exchange-traded funds that amassed junk bonds at a record pacein the first half of 2012 are now attracting unprecedented cash tobuy speculative-grade loans as investors wager that a four-yearrally in the notes is ending.

Blackstone Group LP, the world's largest private-equity firm, isplanning its first ETF that will mostly buy loans, and PyxisCapital LP, spun off from Highland Capital Management LP, announcedits first such fund last week. Invesco Ltd.'s PowerShares SeniorLoan fund, started two years ago as the first ETF solely dedicatedto loans, has grown to become the third- biggest speculative-gradedebt ETF with $1.2 billion of assets.

ETFs, which allow investors to speculate on securities withoutactually owning them, are shifting into floating-rate senior loansas concern mounts that junk bonds are losing momentum after gaining114 percent since 2008. The gap between yields on bonds and loanshas fallen to less than half the historic average amid the FederalReserve's actions to stimulate the economy.

“Loans are a compelling asset class compared to high yield atthese levels,” said Jason Rosiak, the head of portfolio managementat Pacific Asset Management, the Newport Beach, California-basedaffiliate of Pacific Life Insurance Co. “ETFs regardless of theasset class are becoming a more widely used vehicle to express aview.”

Flows into ETFs that buy bank debt reached a record $124.2million in the week ended Oct. 24 and have accounted for 17 percentof all deposits into leveraged-loan funds since July, according todata compiled by Royal Bank of Scotland Group Plc. The averagetrading volume in PowerShares loan ETF shares has surged to 1.5million over the past five days, almost three times the averageover the past six months, according to data compiled byBloomberg.

The five-biggest ETFs that focus on speculative-grade corporatenotes have lost $1.61 billion of assets since reaching a peak of$32 billion on Sept. 20, while the funds that buy loans on suchcompanies reported $467.6 million of deposits.

Yields on junk bonds were 42 basis points more than those onloans as of Nov. 9, according to JPMorgan Chase & Co. data.That compares with an average 103 during the past three years.Loans were paying as much as 13 basis points more than junk bondsin mid-September, the analysts said.

Easier Trade

Leveraged loans are the latest assets to benefit from ETFs thathave attracted buyers from retirees to the biggest banks becausethey're easier to trade than the underlying debt. Loans trade lessfrequently than bonds, are only available in over- the-countermarkets to institutional investors and may take weeks to officiallychange hands after a sale. Shares of an ETF trade like stocks andprices are reported in real time.

“Investors have said they want another way to manage theirportfolios,” said Diane Vazza, the head of Standard & Poor'sglobal fixed-income research in New York. “High-yield ETFs were anatural. Loans are an extension of that.”

Elsewhere in credit markets, Eastman Kodak Co. said it arranged$793 million in financing from some creditors to exit bankruptcy asa commercial-printing company by mid-2013. Firth Rixson Ltd., anaerospace-industry supplier of engineered metal, is said to beseeking $680 million of loans to refinance debt. British AmericanTobacco Plc raised 750 million euros ($953 million) in its firstbond sale in the currency in a year.

The Markit iTraxx Europe Index, a credit-default swaps benchmarkthat investors use to hedge against losses or to speculate on thecreditworthiness of 125 investment-grade companies, increased onebasis point to 133 basis points at 12:05 p.m. in London. In theAsia-Pacific region, the Markit iTraxx Asia index of 40investment-grade borrowers outside Japan fell two basis points to123.

Credit swaps pay the buyer face value should a borrower fails tomeet its obligations, less the value of the defaulted debt. A basispoint equals $1,000 annually on a contract protecting $10million.

Centerbridge Capital Partners, GSO Capital Partners, UBS AG andJPMorgan Chase & Co. are among second-lien creditorsparticipating in Kodak's financing, which will be used duringbankruptcy and can partly be converted to fund the emergingcompany, Rochester, New York-based Kodak said yesterday in astatement. The agreement requires court approval.

Firth Rixson

Funding is conditional on selling its patent portfolio for atleast $500 million, which Kodak said it “is confident it willachieve.” Converting the debt for use by the emerging companyrequires progress in the sale of two business units, and theresolution of the company's U.K. pension obligations.

Firth Rixson's debt due in June 2017 will pay interest at 4.75percentage points to 5 percentage points more than the Londoninterbank offered rate, according to a person with knowledge of thetransaction, who asked not to be identified because the informationis private. Libor, a rate banks say they can borrow in dollars fromeach other, will have a 1.25 percent floor.

The Sheffield, England-based company is proposing to sell thedebt at 99 cents on the dollar, the person said, reducing proceedsfor the company and boosting the yield to investors.

British American Tobacco, Europe's largest cigarette maker, soldbonds due in January 2023 to yield 75 basis points more than themid-swaps rate, according to data compiled by Bloomberg, tighterthan initial guidance of 80 to 85 basis points.

BAT's sale is the company's first in the common currency sinceit raised 600 million euros of 10-year bonds on Nov. 9, 2011 at ayield of 123 basis points more than swaps, data compiled byBloomberg show.

Blackstone is working with State Street Corp. to create theBlackstone/GSO Senior Loan Portfolio, which will seek to invest atleast 80 percent of its assets in leveraged loans and trade underthe ticker SRLN, according to a filing with the Securities andExchange Commission on Oct. 31.

The fund, which aims to return more than the S&P/LSTA U.S.Leveraged Loan 100 Index, will be overseen by Blackstone managingdirectors Daniel McMullen and Lee Shaiman, the document said. Itdiffers from Invesco's leveraged-loan ETF in that it will beactively managed, rather than seeking to mirror the returns of abenchmark index.

Junk Shift

Pyxis Capital, which is based in Dallas, and has $2.4 billionunder management, started the Pyxis iBoxx Senior Loan ETF on Nov.7, the company said in a statement. The fund, which trades underthe ticker SNLN, seeks to track the returns on the Markit iBoxx USDLiquid Leveraged Loan index.

Investors funneled $568 million into U.S. leveraged-loan fundsin the five days ended Nov. 7, the most since the week ended May18, 2011, with $99 million going to ETFs, according to datacompiled by RBS. The loan funds have reported $3.3 billion ofinflows since Sept. 12 while junk-bond funds in the region reported$427 million of withdrawals, the data show.

In the first five months of the year, the biggest junk-bond ETFsincreased their assets by $8.16 billion, Bloomberg data show.

“People are searching for yield,” said Deborah Fuhr, who helpedfound the London-based research firm ETFGI this year after headingETF research at money manager BlackRock Inc. “It's harder to findproducts that historically have been able to generate junk-bondlevel returns.”

Yields on speculative-grade bonds plunged to a record low of6.84 percent on Oct. 18 before rising to 7.1 percent on Nov. 9,according to Bank of America Merrill Lynch index data.

Investment managers are increasingly turning to ETFs since it'seasier to allocate money by purchasing shares sold at $100 or less,Fuhr said. Bonds are typically available for sale in $1,000increments.

The notes have had annualized returns of 22 percent sinceDecember 2008, when the Federal Reserve began holding its benchmarkinterest rates at zero to 0.25 percent. The central bank also plansto buy $40 billion of mortgage bonds a month in its third round ofdebt purchases aimed at igniting an economy that's expected to growat a rate of 2 percent next year, according to economists surveyedby Bloomberg.

Leveraged loans have returned 9.3 percent this year and 58percent since 2008, when spiraling declines in mortgage values ledto the demise of Lehman Brothers Holdings Inc.

Active Role

Loan investors usually play a more active role in determiningnew covenants protecting creditors than bond buyers and may chooseto allow a company to amend existing deal documents, according toRobert Cohen, a senior credit analyst at Los Angeles-basedDoubleLine Capital LP, which oversees $45 billion in assets.

Investors also may want their fund managers to have expertise inestimating the potential recovery on distressed credits from theleveraged-buyout boom from 2005 through 2007, which are asignificant part of loan indexes, he said.

“All of these issues suggest that active management is the wayto go,” Cohen said in an e-mail.

Invesco's ETF has gained 8.7 this year, 0.64 percent less thanthe S&P/LSTA Leveraged Loan 100 Index that it seeks to match,Bloomberg data show. It has increased its assets by $1.1 billionthis year with its share price rising $1.01 to $24.82, the datashow.

“Because of the really strong demand for high-yield bonds thatwe've seen for the past year, they're now yielding about the sameas bank loans,” Rosiak said. “In the near term, I'd rather behigher up in the capital structure and floating-rate withloans.”

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