Uncategorized
Track record, size, loan quality and liquidity mattered in 2019
admin | January 31, 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.
CLO managers’ record of excess return on their loan portfolios going into last year helped predict their performance in 2019, but other things mattered, too. Bigger operations, stronger loan collateral and portfolio liquidity also helped separate the winners from the pack. With the average leveraged loan trading over the widest range since 2015 and 2016, last year offered the latest test of managers’ ability to navigate changing markets.
A good pedigree helped
Managers with a strong record of excess return going into 2019 generally showed good results during 2019. But measuring track records is a subtle business. Amherst Pierpont measures total returns from price and cash flow for every leveraged loan portfolio backing any active or retired CLO. The analysis kicks out a measure of market sensitivity, or beta, for each deal and each manager and a measure of average excess return, or alpha. Alpha gets refined into an information ratio, a traditional gold standard for measuring the stability of excess returns.
Managers with high information ratios heading into 2019 generally delivered higher alpha in 2019, although results varied significantly even for managers with the same information ratio at the start of the year (Exhibit 1). For managers heading into 2019 with an information ratio of 0.0, for instance, or a track record of no average excess return, the amount of total return in 2019 coming from alpha varied from roughly 1% to -3%. For managers starting 2019 with an information ratio of 0.45 or higher, total return in 2019 from alpha ranged from 1.47% to -1.54%.
Exhibit 1: High information ratio going into 2019 helped predict high alpha
Note: Information ratio as of 12/31/18 and total return from alpha from January through December 2019. Both measures available for 99 CLO managers. Source: Amherst Pierpont Securities
Other things mattered
To better understand other factors that might have created the differences in manager alpha last year, Amherst Pierpont looked at potential contributions from a few sources:
- Manager size. CLO managers probably have an optimal size: large enough to afford an analyst staff able to cover all investable credits in the leveraged loan market but not so large that the portfolio converges toward the index.
- Loan collateral. Weighted average rating factor, weighted average spread and diversity score all usually govern managers’ allowable set of investments, so it seems reasonable that they might affect potential returns. Loan price also matters, with lower prices often limiting flexibility to trade.
- Portfolio liquidity. More liquid portfolios, or ones with a higher weighted average bid depth, should have more flexibility to rebalance a portfolio to reflect changing views of the market.
A simple model considering information ratio along with all of these other factors finds that, except for diversity score, all had significant influence on CLO manager alpha in 2019 (Exhibit 2). The model explains more than half the variability in 2019 manager alpha. A couple of observations:
- For every 1 bp rise in information ratio at the start of 2019, manager 2019 alpha tended to end 2019 up 1.583 bp
- For every $1 billion in additional AUM, manager alpha tended to end 2019 up 4.5 bp
- For every $1 higher in weighted average portfolio loan price at the start of 2019, manager alpha ended higher by 55 bp
- For every 100 points higher in weighted average rating factor, alpha came in 25 bp higher.
- For every 10 bp in additional weighted average spread at the start of 2019, alpha end lower by 39.7 bp
- For every additional point of bid depth, alpha came in higher by 86.3 bp
- Diversity score had no significant influence
Exhibit 2: Alpha in 2019 turned on prior track record, size, collateral and liquidity
Note: WAS and bid depth showed a correlation of 0.72. To address the multicollinearity, the analysis first regressed manager 2019 alpha against all variables except bid depth. The analysis then regressed residuals from the first regression on bid depth and bid depth squared to capture nonlinearities. Source: Amherst Pierpont Securities.
Lessons learned
The recipe for good performance in 2019 started with a good prior track record of delivering excess returns. It also included sufficient organizational size, loans with lower spread despite a higher rating factor and good liquidity. The contribution of organizational size to performance is probably more complicated, than a simple linear rise in alpha with AUM, however. A number of managers with average or lower AUM also performed well in 2019, and informally these often seem to be affiliates of larger platforms with a focus on leveraged credit. AUM in leveraged credit across a manager’s platform may be a better measure of organization capacity than AUM in CLOs alone.
The lesson here seems to be that volatile markets reward managers able to monitor quickly shifting credits and then trade on informed views. The manager needed enough liquidity to express those views. In earlier markets, portfolios with higher risk and less liquidity showed good alpha as carry compounded to their advantage. In 2019, however, the receipt for alpha changed.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
