admin | March 6, 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.
A loan market that rallied most days from mid-November to mid-February has given the upper hand to some of the most reliable producers of CLO loan excess return. For the three months ending in February, more than 66% of managers with five or more active deals beat the S&P/LSTA index after accounting for broad market performance, or portfolio beta. Returns ran from Apollo Global Management’s 90 bp of outperformance to the weakest manager’s 83 bp of underperformance. But CLO managers now face a sharp market downturn.
The leader and the laggard
Apollo managed to squeeze excess return out of all 16 active deals tracked by Amherst Pierpont (Exhibit 1). At the high end, ALM 2013-8A delivered 135 bp of excess return while, at the low end, RRAM 2018-5A notched only 4 bp. Amherst Pierpont captures performance for deals reporting by the twentieth day, with performance after that going into the next month.
Apollo historically has run portfolios that track total returns in the S&P/LSTA index with a beta of 0.94, meaning a 1% return in the index came with an average Apollo return of 0.94%. From mid-December through mid-February, the index returned 2.63% while Apollo returned an estimated 3.37%. Apollo’s portfolio beta would have predicted returns of only 2.47%, so the manager delivered excess of 0.90%.
Apollo currently holds portfolios with average weighted average price (63 percentile), high weighted average rating factor (86 percentile), average weighted average spread (49 percentile) and high liquidity (79 percentile). This kind of profile also did very well through the volatile markets of 2019 (see Track record, size, loan quality and liquidity mattered in 2019).
Exhibit 1: All of Apollo’s deals delivered alpha for the quarter ending in February
Note: Performance for managers with five or more deals tracked by APS. 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 each manager’s active 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 had a mixed record across deals tracked by Amherst Pierpont, outperforming the index by 33 bp on its best deal but underperforming by 346 bp on its worst (Exhibit 2). This manager tends to take higher risk than the broad market, signaled by a beta of 1.13. The index returned 2.69% for the three months ending in February while the manager returned 2.20%. Since the manager’s beta would have predicted returns of 3.03%, alpha comes out to -0.83%.
The lagging manager for the most recent period holds portfolios with a low weighted average price (5 percentile), high weighted average rating factor (75 percentile), high spread (88 percentile) and high bid depth (81 percentile).
Exhibit 2: A mixed record for the lagging manager, with some sharp underperformance
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities.
A sharp drop in returns recently
Returns on leveraged loans have turned down sharply since most managers last reported results. The S&P/LSTA index has lost 1.82% since February 22, one of the sharpest losses over a few weeks since in at least five years. Results in 2019 pointed to the importance of some key factors:
- Good trailing track record of reliable excess return
- Size and scale, which arguably ranges between $5 billion and $10 billion of AUM in leveraged credit including CLOs, sufficient to field a strong credit team without converging toward index returns
- A tendency to hold the strongest names in any rating category, often reflected by a WARF percentile that is higher than the manager’s WAS percentile, and
- Enough liquidity in the loan portfolio, reflected by bid depth, to allow the manager to trade on changing views of the market
Manager should remain an important element in CLO returns over the next few months as the economic impact of coronavirus becomes clearer.
The list of managers adding excess return through February appears below (Exhibit 3).
Exhibit 3: CLO managers adding excess return
Note: for methodology, see note for Exhibit 1. Source: Amherst Pierpont Securities.
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