By the Numbers
Low beta wins again in CLO loan portfolio returns
This material is a Marketing Communication and does not constitute Independent Investment Research.
Returns in the average CLO manager’s loan portfolio continue to trail the broad market after adjusting for risk. But managers that build portfolios with stable or low beta returns continue to beat both the passive benchmark and their peers. Once again in performance through March, the pattern shows up again. It could come from the systematic undervaluation of safer, low-beta loans and the overvaluation or riskier, high-beta loans. Or it could come from holding illiquid loans. The safe-versus-risky theory looks more likely, lifting the quality of returns on CLO debt and equity.
Managers trailed the market index by 3 bp through January
After accounting for CLO reporting dates, the Morningstar/LSTA leveraged loan index returned 3.26% for the three months through March. The average loan portfolio for managers with five or more actively tracked deals had a beta—or sensitivity to the loan index—of 1.021. With that beta, the average loan portfolio should have returned 3.33%. But managers weighted by assets under management instead delivered a return of 3.30%, trailing the index (Exhibit 1).
Exhibit 1: Average CLO managers’ performance trailed the broad market by 3 bp
Note: (1) Each reporting period includes the most recent three months. For example, the reporting period ending in Mar 2024 includes the average manager performance in the past three months ending on or before Mar 20, 2024. (2) The March reporting period data shows the average excess return relative to the Morningstar/LSTA total return index for 76 managers with five or more active deals.
Source: INTEX, Markit, Santander US Capital Markets LLC.
Of the 76 managers tracked, 34 outperformed the leveraged loan index and 42 underperformed. Individual managers’ excess returns to the index through March ranged from a high of 42 bp to a low of -66 bp (Exhibit 2).
Exhibit 2: CLO manager loan portfolio performance through March varied widely
Source: INTEX, Markit, Santander US Capital Markets LLC
Low-beta managers continue to outperform the index and their peers
One of the most reliable results from tracking manager loan portfolio performance has been the link between portfolio risk and portfolio excess return. Each manager shows risk as a beta or multiple of the broad market index. A beta less than 1.0 indicates less risk than the market average and a beta greater than 1.0 indicates more risk. Managers with a beta less than 1.0 routinely outperform the market while managers with a beta greater than 1.0 routinely underperform. That was true again for the three months ending in March either using the average beta for the 76 managers tracked or using the beta of the more than 2,200 deals tracked (Exhibits 3A, 3B). Lower manager beta tends to come with positive excess return, higher manager beta comes with negative excess return. The same trend is even more pronounced for individual deals
Exhibit 3A: Managers with low beta generally outperformed through March
Exhibit 3B: Underlying deals with low beta generally outperformed through March
Source: INTEX, Markit, Santander US Capital Markets LLC.
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 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 I would lean toward betting against beta as 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 March, Bardin Hill, Anchorage, Invesco, Guggenheim and Elmwood make up the Top 5 in excess return with KKR, ICG, Octagon, MJX and American Money rounding out the Top 10 (Exhibit 4).
Exhibit 4: CLO managers ranked by excess loan portfolio return through March
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 SanCap’s latest CLO manager bubble chart (Exhibit 7) and to data on more than 138 managers and more than 2,200 active and expired deals is here.
Exhibit 5: SanCap CLO manager bubble chart
Note: The size of each bubble reflects manager long-term beta.
Source: INTEX, Markit, Santander US Capital Markets LLC
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