By the Numbers
Smaller loans help lift CLO managers over the index
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.
Giving up a little liquidity to get more spread has made for a winning strategy in CLO loan portfolios lately. The average portfolio took slightly more risk than the market index for the three months ending in August. But even after accounting for the extra return to extra risk, the average manager outperformed the broad market by 5 bp. A noticeable part of the excess return came from holding loans from smaller, less liquid issuers.
A win for the average manager
The average CLO manager of five or more active deals returned 0.88% in the loan portfolio for the three reporting periods ending in August while the S&P/LSTA Total Return Index over the same periods posted returns of 0.80%. With an average market beta of 1.03, reflecting slightly more risk than the broad market, the average manager return should have returned 0.83%. Excess return, or gross return net of beta-adjusted return, came to 5 bp.
Risk and return ranged as usual across managers. Manager betas ranged from 0.89 to 1.25, indicating underlying loan portfolios with 89% to 125% of the risk of the market index. Beta summarizes CLO loan portfolio risk. Excess return through August ranged across managers from -0.24% to 0.66%.
Relatively stable loan pricing has made carry a bigger part of portfolio return. Loan prices rebounded aggressively after March 2020 but have priced above $98 since May (Exhibit 1). Loans with a higher weighted average rating factor, higher weighted average spread and higher beta have outperformed the broader index.
Exhibit 1: The average leveraged loan has priced above $98 since May
Source: Bloomberg, Amherst Pierpont Securities
Signs that less liquid loans are adding to excess return
The correlations between portfolio attributes and excess return point to the less liquid debt of smaller issuers as an important part of recent stronger performance. Bid depth or the number of market-makers in a given loan shows the strongest correlation to excess return at -0.53 (Exhibit 2). As bid depth goes down, excess return goes up. Of the 10 managers with the highest excess returns through August, half had a portfolio bid depth in the lowest 20% of CLO managers. Smaller, less liquid loans also commonly have higher spreads and ratings factors, reflecting issuer product or customer concentrations. WAS at 0.46 and WARF at 0.33 also show notable correlation to recent excess return.
Exhibit 2: Stronger correlation between excess return and WAS, WARF and bid depth suggest value in smaller, less liquid loans
Note: Correlation between excess return on the CLO loan portfolio for the three reporting periods ending 7/21/21 to 8/20/21 and the average portfolio attribute as of 5/28/21. N = 70.
Source: Intex, Amherst Pierpont Securities.
A strong 43 out of 70 managers with five or more active deals—or 61%—added excess return for the three reporting periods through August (Exhibit 3). The Top 5 included ZAIS, Marathon, Shenkman, Anchorage and Halcyon.
Exhibit 3: CLO managers adding excess return to loan portfolio performance through August
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 manager 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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