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Picking managers for turbulent times
admin | October 25, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
CLO managers holding higher quality debt have delivered relatively good returns lately as performance in leveraged loans continues to weaken, and these managers could keep delivering through likely weak loan performance ahead. Managers holding stronger portfolios generally delivered some of the best excess return in the three months ending in September. After accounting for each manager’s broad market exposure, or beta, returns ranged from 66 bp of outperformance on loan portfolios managed by Oak Hill Advisors to 148 bp of underperformance from the poorest performing manager.
The leader and the laggard
Oak Hill Advisors’ excess return came from generally consistent performance across the 11 deals tracked by Amherst Pierpont (Exhibit 1). Historic performance in the manager’s leveraged loan portfolios generally has tracked S&P/LSTA Index returns with a beta of 0.88, meaning index returns of 1% came with an average Oak Hill return of 0.88%. For the three months ending in September, the index returned 0.71%. Oak Hill’s beta would have projected returns of 0.63%. But since the manager’s portfolios instead delivered 1.29%, the alpha amounted to the difference, or 0.66%.
Oak Hill currently holds loan portfolios with a high weighted average price (95 percentile), a medium weighted average rating factor (66 percentile), a relatively low spread (34 percentile) and a low diversity score (29 percentile). Oak Hill tends to focus on fewer credits than the industry average and take more concentrated positions.
Exhibit 1: Consistent excess return, or alpha, for Oak Hill through September
Note: Performance attribution starts with calculated total return on the leveraged loan portfolio held in each CLO for the 3-month reporting period ending on the indicated date. CLOs, even with a single manager platform, may vary in reporting period. The analysis matches performance in each period to performance over the identical period in the S&P/LSTA Leveraged Loan Index. Where a deal has at least 18 months of performance history since pricing and no apparent errors in cash flow data, the analysis calculates a deal beta. The deal beta is multiplied by the index return to predict deal return attributable to broad market performance. Where no beta can be calculated, the analysis uses the average beta across a manager’s deals weighted by the average deal principal balance over time. Any difference between performance attributable to beta and actual performance is attributed to manager alpha. Source: Amherst Pierpont Securities
The poorest performing manager also showed consistency across seven deals tracked by Amherst Pierpont (Exhibit 2). This manager has generally tracked S&P/LSTA index returns with a beta of 1.18. For the three months ending in September, index returns over this manager’s reporting period hit 0.77%. The manager’s beta would have projected returns of 0.90%. But the manager instead delivered -0.58%, for an alpha of -1.48%.
In contrast to Oak Hill, the lowest ranked manager tends to carry loans with relatively low prices (11 percentile), high rating factor (77 percentile), high spreads (94 percentile) and average diversity (46 percentile).
Exhibit 2: Consistent negative alpha for the laggard
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
A wide range of results
Amherst Pierpont currently reports rolling 3-month returns across 66 managers. Each manager has at least five CLOs and shows sufficient return data for calculating a reliable beta. The firm tracks but does not report returns across another 42 managers with fewer deals. Across managers with reported returns, excess performance varied widely (Exhibit 3). Managers showed an average excess return of -5 bp, a median of 1 bp and a standard deviation of 43 bp.
Exhibit 3: A wide range of excess return for managers tracked by APS
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
Lower beta has helped lately
Holding stronger portfolios and trading with a lower beta to the overall market has helped more managers than just Oak Hill. The 39 managers with a beta of less than 1.0—managers holding less market risk than the S&P/LSTA Index—showed an average alpha through September of 4 bp, while the 27 managers with a beta of 1 or higher showed an averge of -19 bp (Exhibit 4).
Exhibit 4: Managers with lower beta showed more alpha through Sep
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
Looking ahead
The rising share of ‘B+’ and lower rated loans continues to pose risks to CLOs from even modest weakness in the economy or the issuers’ businesses, both from the possibility of downgrade to ‘CCC’ and from sharp drops in price that could impair market value overcollateralization. Managers with stronger portfolios and the ability to add value above pure beta exposure should serve CLO debt investors well (Exhibit 5).
Exhibit 5: CLO manager alpha leaders for the three months ending in September
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
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