Loan Fund Assets Rise $1.2 Billion as Fed Hikes Rates

Leveraged loan mutual funds and ETFs pulled in $1.2 billion in August as investors repositioned ahead of the Federal Reserve's first rate hike in more than three years, according to Morningstar data. The inflows have continued into September.

The Fed raised its overnight funding rate by 0.25 points on Sept. 16, to a range of 3.75-4.00%. The move raises the baseline interest return on floating-rate loans, the core appeal of the asset class in a tightening cycle.

The hike followed a surge in Treasury yields and oil prices. Ten-year Treasury yields have climbed from about 4% to 5% since the war in Iran began, and inflation readings have stayed well above the Fed's 2% target. The Sept. 16 decision ended an eight-month period in which rates sat at a relative minimum; the last cut came in December 2025.

Investors expect more tightening. CME's FedWatch Tool shows a better-than-50% probability of another 25-basis-point hike at the October meeting, and a target rate of 4.50-4.75% by the end of 2027.

The rotation is playing out on both sides of the credit fund market. As money returned to loan funds, fixed-rate high-yield funds saw outflows accelerate, including a $2.5 billion withdrawal in the week through Sept. 16, according to Morningstar.

Loans rebound, led by software

Prices in the leveraged loan market are rising alongside the inflows. The weighted average bid price added 41 basis points in August to 95.58 and inched up further to 95.68 by Sept. 21, according to the data. Software sector loans, which sold off earlier this year, have led the rally.

The pattern has historical support. Rate-hiking cycles have frequently coincided with growth in loan fund AUM, while assets have generally contracted during rate-cutting cycles.

Funds grow, but the index grows faster

Since the end of March, AUM at loan funds has grown by $2.7 billion, to $96 billion. Even so, loan funds' share of the Morningstar LSTA US Leveraged Loan Index has slipped to 6.37%, the lowest level since September 2009.

The decline extends a longer-term trend: loan fund AUM has shrunk as a portion of the expanding universe of syndicated leveraged loans, while CLOs have become the dominant investors in the asset class.

The dynamic leaves retail-facing loan funds capturing only a sliver of a market whose growth is increasingly driven by structured credit vehicles. If the Fed delivers the further hikes markets are pricing in, loan funds will keep earning their floating-rate premium — but CLOs, not funds, will hold the expanding balance sheet.