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By Miles Li & Luke Lu, Yield Book Research
As global markets face prolonged macroeconomic headwinds and a potential recession, institutional investors are turning more attention to manager performance as a guidance for investments in the Collateralized Loan Obligation (CLO) market, whose unique feature is active management of underlying collateral assets.
During the reinvestment period, experienced managers with a strong credit selection skillset and a sound risk framework can add significant value by taking advantage of market volatility. In times of uncertainty, investors are also more selective with their choice of managers.
So, how should we view CLO managers when the markets are under pressure? What are the factors to track when evaluating manager performance?
In the Yield Book CLO Market Overview monthly publication, launched recently, we proposed looking at manager performance from four major aspects, including size, collateral quality, equity favour, and active management. We focused on the broadly syndicated loan (BSL) CLO managers only as this is the vast majority of the market.
In particular, we dissected manager performance through 11 different metrics, covering assets under management (AUM), WAS/WARF, Diversity, Junior OC cushion, Caa/CCC %, Second Lien %, Defaulted %, WAP, Notional Par Build, Equity Cash on Cash %, and Equity Market Value NAV. Below we showcase the results of three metrics as examples of our approach, touching on collateral market movement, risk/reward and collateralization aspects.
Amid the recent market turbulence, the weighted average market price for CLO collateral loans fell to 91.7 in June month-end, hitting the lowest spot since July 2020. Even the top managers have average loan prices falling below 94. That said, the current environment can present opportunities for active CLO managers to pick credits and build par by buying deeply discounted loans.
The risk/reward trade-off is always at the core of credit selection. To measure this, we have chosen the WAS/WARF ratio as one of the credit selection differentiators. The top performing managers typically are able to pick up excess spreads without sacrificing too much in loan quality. The chart below shows the WAS/WARF ratio of the market average (bars) and top 10 managers with the highest WAS/WARF ratio calculated by the most recent trustee reports (lines) for period from January 2020 to June 2022.
Separately, we employed Notional Par Build to evaluate managers’ ability to strengthen collateralization, by comparing the current excess par amount to the initial excess par as of effective date. Illustrated by the table below, the top 10 managers were all able to achieve a notional par build over 0.7% vs. the market average of 0.18% in June.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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