An Overview of Amherst Pierpont’s approach to CLO evaluation
Amherst Pierpont evaluates CLOs by analyzing both the asset and liability sides of the transaction—the asset side being the evolving portfolio of leveraged loans and the liability side being the debt issued to finance the loans.
To the asset side, Amherst Pierpont applies some basic ideas from the Capital Asset Pricing Model. That model uses portfolio total return to capture investment risk and reward and attributes those qualities to the portfolio’s broad market exposure, or beta, and the manager’s realized excess return, or alpha. Amherst Pierpont further refines alpha into portfolio information ratio, which measures the stability of alpha over time. In practice, Amherst Pierpont calculates periodic total returns before fees of almost every CLO ever issued and benchmarks performance against the S&P/LSTA Total Return Index. This approach produces beta, alpha and an information ratio. These statistics may vary over time as each CLO adds to its performance record. These measures get weighted together into summary measures for each CLO manager. A beta greater than 1.0 indicates a manager takes more risk than the average outstanding leveraged loan, and a beta less than 1.0 indicates a manager takes less risk. A positive information ratio indicates a manager adds value before fees to portfolio performance relative to a passive index, and a negative information ratio indicates a manager subtracts value.
Some CLO deals and some CLO managers will not show asset performance statistics. That happens if a deal has fewer than 12 independent periods of total returns or a manager has fewer than 32 independent periods of total returns, which are minimums for estimating reliable statistics. APS begins calculating total returns after the first payment date to avoid some of the noise associated with building up a loan portfolio. For some deals with especially volatile cash flows after the first payment date, APS waits an additional three months to start calculating returns. That means a deal will start showing asset performance statistics somewhere between 12 months and 15 months after the first payment date. Statistical estimates rapidly become more reliable with more observations, with accuracy starting to plateau at 32 observations or more. APS may also choose to hold back performance statistics altogether if interest received on a CLO portfolio does not correspond closely enough with proprietary APS estimates.
To the liability side, Amherst Pierpont applies a proprietary method for estimating quality of CLO debt execution holding market conditions roughly constant. For almost every CLO ever issued, the analysis compares the cost of funds at each rating level to other deals in the market under similar conditions. Results for each rating level get weighted together into a single measure for each deal. Measures for each deal get weighted together into a summary measure for each manager. A positive Liability Z-Score indicates a deal placed debt at levels wide to its peers under similar market conditions, and a negative Liability Z-Score indicates a deal placed debt tight.
The Amherst Pierpont framework then uses information ratio, Liability Z-Score and beta to screen for relative value across CLO equity and debt. For equity, a high information ratio and a negative Liability Z-Score means that both the asset and liability side of the deal are adding to equity returns. For equity classes with similar information ratio and Liability Z-Score, a low beta means equity performance comes with low volatility of NAV while a high beta means high volatility of NAV. For debt, a high information ratio and high Liability Z-Score means the deal manager has added value to portfolio performance but tends to issue debt at wide levels. For debt with similar information ratio and Liability Z-Score, a low beta means low equity volatility and a high beta means high equity volatility. Debt issued by equity with low volatility, all else equal, should trade at a tighter spread than debt issued by equity with high volatility.
IMPORTANT: The estimates of alpha, beta, information ratio and Liability Z-Score for CLOs and CLO managers provided by the APS CLO Performance site reflect past investment performance and are not guarantees of futures results.
Key Terms
Asset: The category from 1 to 5 where a manager’s or deal’s information ratio ranks, with 1 being the lowest 20% of information ratios and 5 being the highest 20%
Asset Rank: A manager’s or deal’s rank on information ratio out of all managers or deals ranked
Alpha: The average monthly percentage return delivered by a CLO leveraged loan portfolio, after adjusting for risk, relative to the performance of the S&P/LSTA Total Return Index.
Beta: The amount of risk in a CLO leveraged loan portfolio relative to the S&P/LSTA Leverage Loan Index. A beta of 1.0 means a portfolio matches the index risk, a beta less than 1.0 means a portfolio has less risk and a beta greater than 1.0 means a portfolio has more risk.
CLO Graph: An interactive bubble chart of CLO managers with data on each
Deal Long-Term Performance: CLO deal asset and liability statistics including all deals issued in January 2011 or afterwards over all periods from January 2011 to the present
Deal Total Return: A deal’s 1-, 3-, 6- and 12-month total return. The statistics reflect total return over the deal’s recent reporting periods, the return on the S&P/LSTA Total Return Index over the same periods, the part of the deal’s return from beta, calculated by multiplying the index return by the deal’s beta, and the part from alpha, calculated by subtracting the part from beta from the deal’s overall return.
Information Ratio: Alpha converted into standard deviations from zero. An information ratio of 1.0 means a CLO leveraged loan portfolio has delivered excess return 1.0 standard deviations above zero, and -1.0 means excess return 1.0 standard deviations below zero. Assuming a normal distribution, the information ratio implies a probability that a portfolio in any given period will outperform or underperform the index. A portfolio with an information ratio of 1.0 will underperform the index 16% of the time, and a portfolio with an information ratio of 0.5 will underperform 31% of the time.
Liability: The category from 1 to 5 where a manager’s or deal’s Liability Z-Score ranks, with 1 being the lowest 20% of scores and 5 being the highest 20%
Liability Rank: A manager’s or deal’s rank on Liability Z-Score out of all managers or deals ranked
Liability Z-Score: The average cost of CLO debt relative to other deals in the market under similar market conditions, expressed as a standard deviation. A negative score indicates debt placed tight to peers, a positive score indicates debt placed wide to peers.
Manager Long-Term Performance: CLO manager asset and liability statistics including all deals issued in January 2011 or afterwards over all periods and across all deals from January 2011 to the present
Manager Total Return: A manager’s 1-, 3-, 6- and 12-month weighted total return including all active deals issued in January 2011 or afterwards. The statistics reflect total return over the manager’s recent reporting periods, the return on the S&P/LSTA Total Return Index over the same periods, the part of the manager’s return from beta, calculated by multiplying the index return by the manager’s beta, and the part from alpha, calculated by subtracting the part from beta from the manager’s overall return.
Number of Deals Used: the number of CLO deals used to calculate displayed statistics
Number of Observations: the number of distinct periods of total return used to calculate displayed statistics
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of Amherst Pierpont’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, Amherst Pierpont may act as a market maker or principal dealer, and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
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