By the Numbers
CLO loan performance rises again with quality
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 loan portfolio of the average CLO has beaten the broad leveraged loan market lately in part because more managers are building quality, stable portfolios. Quality loan books in the three months ending in August added 15 bp in excess return after adjusting for risk while speculative portfolios tacked on only 3 bp in excess. Excess returns improved month-over-month in most loan portfolios, but the rising share of CLO par managed by quality books also helped lift the average.
Quality books outperform the index and peers
Of the near $764 billion in CLO AUM tracked by Santander US Capital Markets, 28% now falls under managers that tend to generate month-to-month returns less volatile than the Morningstar/LSTA Leveraged Loan Index (Exhibit 1). This is up from 26% from last month’s results. These quality managers show an average beta—or sensitivity to the index—of 0.96, implying 4% less risk than the market overall. From June through August, based on the different reporting dates of managers, the index returned 1.39%. Based on the average beta weighted by CLO AUM, quality portfolios should have delivered 1.34%. They delivered 1.49% instead, outperforming by 15 bp.
Exhibit 1: Quality topped the loan market by 15 bp, speculative by 3 bp
Note: Performance the three monthly reporting dates before August 20, 2024, for managers with five or more deals issued since January 1, 2011, and tracked by Santander US Capital Markets. 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 Morningstar/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 attributes to beta and actual performance is attributed to manager alpha.
Source: INTEX, Markit, Santander US Capital Markets LLC
The balance of the CLO AUM tracked by Santander US Capital Markets falls under managers that tend to generate more volatile month-to-month returns. The volume of AUM under speculative managers dropped to 72% through August from 74% the month before. These speculative managers show an average beta of 1.04, implying 4% more risk than the overall market. Over a period that differed slightly from quality managers due to different deal reporting dates, the index returned 1.32%. Based on beta, the speculative portfolios should have delivered 1.37%. Instead, they delivered 1.40%, outperforming by 3 bp.
More than just management style
Across the 80 managers tracked, a drop in beta of 0.1 or, equivalently a drop of 1% in portfolio risk, raised excess return through August by an average 2.2 bp (Exhibit 2). But beta or manager style explained only 18% of total differences in excess returns across managers, leaving the rest possibly explained by style drift in recent months, other features of the manager or simply error in measuring recent manager beta.
Exhibit 2: A drop in beta of 0.01 lifted excess return by 2.2 bp
Note: See notes to earlier exhibits.
Source: INTEX, Markit, Santander US Capital Markets LLC
Possible explanations for the impact of style
At least two broad possibilities could explain the tendency for excess return to fall as beta increases:
- Risky loans trade rich, safer loans trade cheap. This would happen if managers competing to deliver returns to CLO equity crowd into riskier loans with wider spreads that drive up portfolio beta and drive down the potential for excess return. Crowding into risk arguably leaves safer loans with lower beta trading at much better valuations. A wide range of research often tagged as betting against beta finds this pattern in US equities, 20 international equity markets, Treasury and corporate bonds and futures. If betting against beta is driving CLO loan portfolio beta and alpha, then equity and debt investors are getting a genuinely better investment performance.
- Illiquid loans show low beta, high alpha. Illiquid loans with stale prices show low beta to market indices and high alpha, at least when loan returns are positive. There’s no magic to this. It’s purely from the low correlation between any asset with stale pricing and any more liquid mark-to-market index. If illiquidity is driving CLO loan portfolio beta and alpha, then the better investment performance is more optics than reality.
Both explanations likely contribute to this consistent result in CLO loan portfolios, but betting against beta is likely the bigger effect. Low beta portfolios should deliver better ultimate loan returns or more stable returns or both. Those higher-quality returns should accrue to the benefit of CLO equity and debt.
The rankings are in
For the three months ending in August, CVC, Neuberger Berman, Anchorage, AEGON and Elmwood make up the Top 5 in excess return with TCW, PineBridge, ICG, Allstate and Ares rounding out the Top 10 (Exhibit 3).
Exhibit 3: CLO managers ranked by excess loan portfolio return through August
Note: Performance for managers with five or more deals issued since January 1, 2011, and tracked by SanCap. 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 Morningstar/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 attributes to beta and actual performance is attributed to manager alpha.
Source: INTEX, Markit, Santander US Capital Markets LLC
A link to Santander US Capital Market’s latest CLO manager bubble chart and to data on more than 138 managers and more than 2,200 active and expired deals is here.
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