The Big Idea
Managers chase a hot loan market through July
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 race between the average CLO manager and the broad market in leveraged loans came right down to the wire for the three months ending in July, but the market leaned across the tape one risk-adjusted basis point ahead. The market has rewarded risk well since March 2020, and the average CLO portfolio now carries a little extra. Most managers still struggle to find other ways to add return. But holding smaller, less liquid loans has been one way to get ahead.
Finishing just behind the index
After accounting for managers’ reporting dates, the S&P/LSTA Total Return Index delivered 1.33% over the three reporting periods ending in July. The average loan portfolio for managers with five or more active deals had a beta to the index of 1.03, reflecting slightly more risk than the index itself. With that beta, the average portfolio should have printed 1.37%. But the average portfolio instead gained 1.36%, finishing behind the index by 1 bp.
Managers showed the usual range of risk profiles and excess return. Manager betas ranged from 0.90 to 1.25, indicating volatility of portfolio returns ranging between 90% and 125% of the broad index (Exhibit 1A). After multiplying index returns by each manager’s beta and looking at any return left over, excess return ranged from negative 40 bp to positive 55 bp or more (Exhibit 1B).
Exhibit 1A: Manager average beta through July ranged between 0.90 and 1.25
Note: Manager beta calculated based on active deals with at least 18 months of accurate data. Where no beta can be calculated, the analysis uses the average beta across each manager’s active deals weighted by the average deal principal. Results for managers with five or more active deals only.
Source: Amherst Pierpont Securities
Exhibit 1B: Manager average excess return ranged from (0.40%) to 0.55%
Note: Manager alpha or excess return calculated by multiplying index returns over the deal reporting period by deal beta and subtracting the result from realized returns. Results for managers with five or more active deals only.
Source: Amherst Pierpont Securities
Chasing a hot market
Managers have had to chase a market since March 2020 where taking risk has earned better returns than the index. The index through July has delivered a cumulative 22.5%, but returns have varied on either side depending on risk (Exhibit 2). ‘BB’ loans, which are safer than an index that now averages a ‘B’ credit, have returned a cumulative 14.7%. The 100 largest leveraged loans, which are more liquid than the average index loan, have returned a cumulative 16.3%. ‘B’ loans have generated a cumulative 24.1%, second liens a cumulative 41.9% and ‘CCC’ loans a cumulative 48.4%.
Exhibit 2: With risk has come cumulative return since March 2020
Source: LCD, Amherst Pierpont Securities
Correlates of success
Although there is no single formula for success, managers generating returns beyond those predicted by beta alone have tended to show a few noticeable characteristics:
- Relatively low beta, or lower return volatility than the broad market
- Relatively high weighted average rating factor and weighted average spread
- Relatively low bid depth
This pattern points to portfolios overweight smaller, less liquid loans. These loans tend to show less price sensitivity, lowering their return volatility and their beta to the broad market. Rating agency criteria also tend to penalize loans backed by smaller facilities, raising their WARF and WAS. Issuers of smaller loans tend to have more product concentration, client concentration or both, often warranting a lower rating. But some CLO managers specialize in these loans, arguing that the issuers may still have sound balance sheets with relatively strong margins and relatively low leverage. Good diversification across smaller issuers can mitigate much of the idiosyncratic risk.
Among the 30 managers that beat the index for the three months ending in July, eight or 27% showed average bid depth below the 20th percentile. Of the 38 managers that matched or lost to the index, only five or 13% showed bid depth below the 20th percentile. Names in the Top 30 with lower bid depth included Anchorage (2 percentile), Credit Suisse (20 percentile), Denali (19 percentile), Golub (14 percentile), Guggenheim (12 percentile), Marathon (11 percentile), Napier Park (16 percentile) and ZAIS (8 percentile),
Through July, the Top 5 managers delivering the most excess return included Canyon, ZAIS, Symphony, Anchorage and KKR. The full list of managers finishing ahead of the index is below (Exhibit 3).
Exhibit 3: CLO loan portfolio performance for the three reporting periods ending July 2021
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
Source: Amherst Pierpont Securities
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