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Managers with liquidity lead performance into December
admin | January 16, 2020
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 sharp rebound in leveraged loan prices through December lifted the performance of CLO managers after a volatile fall left most lagging the total returns of the S&P/LSTA index. The share of managers with five or more active deals that beat the index for the three months ending in November had dropped to 38% but rebounded in December to 59%. Manager returns still varied widely after accounting for broad market performance, or portfolio beta, running from a leading 74 bp of excess return from Highland Capital Management to 161 bp of underperformance from the weakest manager.
The leader and the laggard
Highland’s excess return came from five of its six active deals tracked by Amherst Pierpont (Exhibit 1). Only ACIS 2014-3A lagged the index for the December report largely because the deal reports on the twenty-first day of each month. Amherst Pierpont captures performance for deals reporting by the twentieth day, with performance after that going into the next month.
Highland historically has run portfolios that track total returns in the S&P/LSTA index with a beta of 1.03, meaning a 1% return in the index came with an average Highland return of 1.03%. With the index up 1.45% over Highland’s 3-month reporting period through December, portfolio beta would have predicted 1.49% in returns. The manager instead delivered 2.23%, for alpha of 74 bp.
Highland currently holds loan portfolios with a modestly low weighted average price (17 percentile), high weighted average rating factor (71 percentile), lower spread (28 percentile) and a lower diversity score (26 percentile). Highland also shows a very high weighted average bid depth (93 percentile).
Exhibit 1: Most of Highland’s deals delivered strong alpha into December
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, stuck in last place for months, again underperformed across all eight deals tracked by Amherst Pierpont (Exhibit 2). This manager has tracked S&P/LSTA returns with a beta of 0.93. For the three months ending in December, index returns hit 0.93% with the manager delivering -0.75%. Adjusting for beta, the manager alpha came to -161 bp.
The poorest performer also holds a portfolio with a relatively low weighted average price (32 percentile), a low weighted average rating factor (34 percentile), a very high weighted average spread (98 percentile) and a high diversity score (97 percentile). The manager holds a relatively illiquid portfolio, with a low weighted average bid depth (12 percentile).
Exhibit 2: Significant underperformance for the lagging manager
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities.
Liquidity still mattered
The ups and downs of leveraged loan performance since early October continued to make portfolio liquidity valuable (Exhibit 3). Managers at the top of the rankings tended to have relatively high weighted average bid depth while managers at the bottom tended to have relatively low bid depth. Liquidity seemed to allow leading managers to navigate a volatile market more effectively.
Exhibit 3: A roller coaster in leveraged loans before a rally in December
Source: Bloomberg, Amherst Pierpont Securities
The surge in market performance in December lifted the share of managers with excess return to 59% (Exhibit 4). Amherst Pierpont tracked rolling 3-month returns across 66 managers with five or more active deals into December, and 39 of those beat the S&P/LSTA Index. That was a sharp improvement from 38% in November. The average manager that beat the index added an average of 34 bp and a median of 30 bp with a standard deviation of 20 bp. The average manager that unperformed fell behind the index by an average of 56 bp and a median of 55 bp with a standard deviation of 37 bp.
Exhibit 4: A strong 39 of 66 managers tracked beat the index Oct-Dec
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities.
Momentum in the leveraged loan market
The continuing strength in leveraged loan pricing suggests plenty of momentum in loan returns. Managers with high beta portfolios will tend to generate leading absolute returns. But liquidity should still be a valuable source of alpha as managers trade into names most likely to benefit from current bullish conditions.
The list of managers adding excess return through December is below (Exhibit 5).
Exhibit 5: 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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