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Risk takers continued to excel through August

| September 11, 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.

More than half of CLO managers with five or more active deals beat the broad loan market between June and August. The average CLO leveraged loan portfolio gained 6.81% and, after adjusting for broad market exposure, or beta, outperformed the market by 0.28%. Managers who carried portfolios with less liquid or lower priced loans at the end of May delivered more recent excess returns than their peers. As leveraged loans rallied between June and August, the weakest credits came back faster than average and managers with riskier portfolios stayed ahead.

Loan returns rose steadily between June and August (Exhibit 1). The index has now reached about its pre-coronavirus level. After accounting for the various reporting dates of managers, the S&P/LSTA Index gained 6.3% between June and August. Managers held portfolios with an average beta of 1.04, which meant the average manager should have gained 6.53%. With the actual average performance at 6.81%, the average manager outperformed the index by 0.28%.

Exhibit 1: Loan returns have recovered from its pre-Covid level

Source: Bloomberg, Amherst Pierpont Securities

 About 55% of the managers outperformed the index, a small drop from the figures reported by Amherst Pierpont last month (Exhibit 2). Out of the 69 managers tracked for July, seven delivered alpha greater than 1%, while only one trailed the index by more than 1%.

Exhibit 2: More than half of the managers outperformed the index between June and August

Note: data shows excess return only for active deals. Source: Amherst Pierpont Securities.

The weighted average price and bid depth of the portfolio correlated most strongly with recent excess returns (Exhibit 3). Managers who held loans that are priced lower or less liquid delivered higher returns. Additionally, higher exposure to ‘Caa1’ correlated with more recent excess returns. These relationships indicate that managers holding riskier or less liquid loans tended to outperform between June and August.

Exhibit 3: Correlation of portfolio or manager features with recent excess return

Note: data shows the correlation of manager or loan portfolio attribute with managers’ excess return or alpha from June through August only on active deals. Portfolio attributes measured as percentiles. Source: Amherst Pierpont Securities.

The percentage of CLO debt classes put on CreditWatch Negative at the end of May also correlated strongly with recent excess returns. Loans with lower ratings or other indicators of weaker credit tend to have a higher market beta and went on CreditWatch Negative with a higher frequency (Exhibit 4).  For instance, lower priced loans helped explain both the dispersion in CreditWatch Negative actions, according to an earlier APS analysis, and broad market exposure. As the loan market strengthened between June and August, riskier managers benefited more from this rally.

Exhibit 4: Portfolios with higher beta also tended to go on CreditWatch Negative

Source: Amherst Pierpont Securities

The following managers delivered positive alpha in the market between June and August (Exhibit 5). Highland Capital, Marathon, and AXA Investment top the chart this time. The other alpha leaders include ZAIS Group, Steele Creek, American Money, Golub, and Anchorage.

Exhibit 5: Alpha leaders in CLO portfolio performance June-August 2020

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.

 

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