CLO Manager Tier Migration

August 6, 2020

Source: Penn Mutual Asset Management Source: Penn Mutual Asset Management

One of the features that sets collateralized loan obligations (CLOs) apart from other structured credit sectors is the addition of active management. Each CLO has the constant attention of a CLO manager, who can actively trade the underlying portfolio during the reinvestment period in order to maximize the value of the trust. CLO managers have different trading styles and investment strategies, which may or may not align with the interests of the investors in the deal. This differentiation requires CLO investors to analyze manager behavior and often leads to investors creating an approved list. More quantitative approaches include a variety of rankings based on portfolio risk, market execution, liquidity, manager reputation or some combination of the aforementioned factors. These rankings can then lend themselves to categorization in the form of tiering, and in the CLO world, the CLO manager universe is typically classified into three tiers.   

Analytical platforms such as Intex offer plenty of data on manager behavior and analyzing this information can be a critical component for successful CLO investors. However, many investors prefer to go beyond the data and take time to meet with managers in person, either at conferences, at the manager’s office or even through Zoom, to ask pointed questions that may not be covered in typical CLO manager pitch books or investor calls. This more qualitative or personal side of manager due diligence can also affect manager tiering. With the amount of time this manager analysis takes, investors might be tempted to use a “set it and forget it” approach to their manager lists and rankings. However, this week’s chart demonstrates that manager tiering is quite dynamic and deserves a refreshed analysis on a regular basis. For those investors who lack the resources to conduct their own manager analysis internally, some Wall Street researchers, such as those at Wells Fargo, regularly publish excellent analysis and rankings on CLO managers. 

At Penn Mutual Asset Management, we conduct our own internal CLO manager analysis, and part of that analysis includes a risk ranking. This risk ranking incorporates several credit metrics and gives us a feel for how much risk CLO managers are generally taking in their CLOs. We then rank and tier the managers accordingly. This week’s chart shows how the risk ranking and tiering changed from 2019 to 2020, taking into account the effects of the pandemic in recent months. 

Key Takeaway

Compared to other structured credit sectors, CLOs enjoy the enhancement of active management provided by CLO managers. However, investment style and skill can vary materially between managers. This differentiation between managers lends itself to analysis, various rankings and manager tiering. However, research shows that as managers jockey for position in the CLO landscape, their risk profiles can change quite a bit over time. The dynamic nature of CLO manager behavior requires investors to regularly refresh their analysis used to rank and tier managers. 

Tags: CLOs | CLO managers | Active management | risk ranking

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