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Style today predicts style tomorrow
admin | January 24, 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.
The leveraged loan attributes that get so much attention in the CLO market—price, spread, ratings factor and bid depth, among others—do turn out to paint a reliable picture of a manager’s portfolio style. A quick study of loan attributes across managers from the beginning of 2019 to the end shows a generally high correlation. Manager standing relative to peers at the beginning, in other words, generally predicts standing at the end. But some attributes predict better than others.
Investors usually check a handful of loan attributes for each CLO or CLO manager to get a view of portfolio risk. Since mangers have discretion to trade the portfolio during reinvestment, however, attributes today may not reflect attributes tomorrow.
To test the stability of key aspects of managers’ portfolios, Amherst Pierpont took a snapshot of the CLO loan portfolios of 113 managers on December 31, 2018 and again on December 31, 2019. The snapshot included the following:
- Manager AUM in broadly syndicated leveraged loans
- Manager active deal count
- Weighted average spread across all CLOs
- Weighted average rating factor
- Weighted average price
- Weighted average bid depth
- Diversity score
- Second liens as a percent of par
- ‘Caa1’ loans as a percent of par
- ‘CCC’ loans as a percent of par
- Defaulted loans as a percent of par
- Unpriced loans as a percent of par
If managers with high weighted average spread portfolios maintain high spreads and managers with low weighted average spread portfolios maintain low spreads, for instance, the correlation of weighted average spread over time should be high. If managers’ spread varies dramatically as portfolios trade and reinvest, however, correlation should be low.
In general, correlations from the end of 2018 to the end of 2019 look high (Exhibit 1). The correlations of nearly 1.00 for AUM and deal count just say that relatively bigger managers remain big a year later and smaller managers remain small. The strong correlations of nearly 0.90 for diversity score, bid depth and share of second liens also suggests managers stake out relative positions on these attributes and largely maintain them. As for spread, share of ‘Caa1’ and rating factor, correlations also are healthy around 0.80. Only for share of ‘CCC,’ share of unpriced loans and loan price do correlations suggest only modest predictability. And for share of default loans, the level at the end of 2018 predicted almost nothing about the level a year later.
Exhibit 1: Manager portfolio attributes showed high correlation through 2019
Source: Amherst Pierpont Securities
It’s encouraging that diversity score, weighted average spread and weighted average rating factor show strong correlation over time. Deal documents usually require managers to stay inside a set of limits defined by these attributes, and the strong correlations suggests managers do exactly that. But other attributes are telling, too. At least based on 2019, a manager today is very likely to look the same tomorrow.
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