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CLO managers ride a loan roller coaster into November
admin | December 6, 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.
A volatile market in leveraged loans this fall has put a drag on the performance of many portfolios backing CLOs. After accounting for portfolios’ broad market exposure, or beta, the share of managers delivering excess return over the three months ending in November dipped to 38%. The whipsaw in loan performance also turned portfolio returns more into a test of manager skill than portfolio beta. Excess returns ranged from the 59 bp turned in by PineBridge Investments to the 168 bp of underperformance turned in by the bottom performer.
The leader and the laggard
PineBridge’s excess return came from consistently strong 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 1.18, meaning index returns of 1% came with an average PineBridge return of 1.18%. For the three months ending in November, the index returned 0.18%. PineBridge’s beta would have projected returns of 0.21%. But since the manager’s portfolios instead delivered 0.80%, the alpha amounted to the difference, or 0.59%.
PineBridge currently holds loan portfolios with a high weighted average price (78 percentile), low rating factor (36 percentile), a very low spread (2 percentile) and a high diversity score (71 percentile). PineBridge also shows a very high weighted average bid depth (98 percentile).
Exhibit 1: Consistent strong alpha into November across PineBridge deals
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 manager deals weighted by the average deal principal balance over time. A manager’s average beta reflects all deals ever issued or acquired by the platform. Any difference between performance attributable to beta and actual performance is attributed to manager alpha. Source: Amherst Pierpont Securities
The poorest performing manager consistently underperformed across eight deals tracked by Amherst Pierpont (Exhibit 2). This manager has generally tracked S&P/LSTA index returns with a beta of 0.94. For the three months ending in September, index returns over this manager’s reporting period hit -0.01%. The manager’s beta would have projected returns of -0.01%. But the manager instead delivered -1.69%, for an alpha of -1.68%.
In contrast to PineBridge, the lowest ranked manager tends to carry loans with low prices (4 percentile), high rating factor (78 percentile), high spreads (97 percentile) and high diversity (92 percentile). The weighted average bid depth for this manager is notably low (10 percentile).
Exhibit 2: Consistent and significant underperformance for the bottom manager
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
Volatile markets gave advantage to liquid portfolios
Managers had to navigate volatile markets for the three months ending in November. The S&P/LSTA leveraged loan total return index seesawed up and down through the period. Total returns on the broad market fell for the first half of August before steadily rebounding to the end of September. Early October saw another sharp downturn before returns climbed back through the end of November.
Exhibit 3: CLO managers navigated volatile markets through November
Source: Bloomberg, Amherst Pierpont Securities
The volatility seemed to give advantage to relatively liquid loan portfolios. Managers with relatively high weighted average bid depth tended to have more alpha through November than managers with relatively low bid depth (Exhibit 4). Managers with more liquidity presumably could take advantage of the ups and down to trade in and out of positions. More liquid loans also tend to come from better credit, and spreads on ‘BB’ and other relatively highly rated loans have tightened through the fall while ‘B’ and lower rated loans have widened. Flexibility and tighter spreads could have both contributed.
Exhibit 4: Managers with more liquid loans outperformed less liquid peers
Source: Amherst Pierpont Securities
The volatility helped drag the share of managers with excess return to 38% from 48% as recently as September. Amherst Pierpont currently tracks rolling 3-month returns across 63 managers, and only 24 through November added return beyond the index (Exhibit 5). Managers showed an average excess return of -20 bp, a median of -12 bp and a standard deviation of 48 bp.
Exhibit 5: Only 24 of 63 managers tracked beat the index
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
Challenging markets ahead
CLO managers face some challenges ahead as the performance of ‘BB’ and ‘B’ loans continue to diverge. ‘BB’ loans have tightened through the fall and look likely to continue as CLOs try to offset the heavy supply of ‘B-’ loans. ‘B-’ loans, which are at their widest spread to ‘BB’ in 10 years, face some pressure ahead if spreads remain wide. Issuers that need to rollover or refinance debt could have trouble, raising the risk of downgrade. CLO managers will have to navigate those waters, and portfolio liquidity looks likely to remain valuable.
The list of managers adding excess return through November is below (Exhibit 6).
Exhibit 6: CLO manager alpha leaders for the three months ending in November
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities
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