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News Investor’s Corner
‘CLOs are strategic, all-weather investments’
by Lisa Lee
Lisa Lee: Do you think the CLO market has been too sanguine? Do you think there should be more volatility?
Chandrajit Chakraborty: My view is CLOs should be seen as a bit of an all-weather, medium-term investment strategy, where a certain portion of any investor’s allocation should be into this asset class. This is because over a medium-term horizon, CLOs have continued to deliver pretty attractive risk-adjusted returns. And this is going back over every pocket of volatility we have seen, including the financial crisis and COVID.
Obviously, spreads have tightened considerably. It is difficult to say for sure if they will continue to tighten, or widen from here. But whichever direction we go, there will be pockets of volatility. One has to look at it over a longer horizon and incrementally add in exposure in fundamentally good-quality credit. That should always be the approach — not chasing yield at the expense of fundamental credit quality. One has to look at it through more of a strategic view, rather than a purely short-term tactical one.
LL: What worries do you have when you look at the CLO market?
CC: The supply of new loans has been a concern for a while. While CLO new issuance, even though it has slowed a bit following all the announcements, will continue, and is continuing, a large portion of that, as well as the warehouses, are really looking at the cohort of secondary loans. The same loans that are being traded are being put into different warehouses and different CLOs.
Don’t chase yield at the expense of fundamental credit quality
Chandrajit Chakraborty
CIO, managing partner
Pearl Diver Capital
There is a positive side to it and a challenging side. The positive side is that, obviously, if CLO issuance continues to remain strong and loan issuance remains a bit muted, it will create a simple supply-demand imbalance and create a technical support for the loans, which is great for your secondary market trade. Your NAVs remain high, your MVOCs remain high, they trade well, and it’s a great outcome for your existing secondary holding.
But this is probably not really reflecting, in some cases, the fundamental value of these loans — where these loans would have traded if the supply-demand imbalance was not there. Long-duration positions will have to go through a bit of the cycle where some of these loans will see some stresses coming through, and this is perhaps not being reflected in their trading price today. I think that will be something that could drive default rates up, and push recoveries a bit lower.
LL: You invest in the US and Europe, mezz and equity — which do you like most right now?
LL: You invest in the US and Europe, mezz and equity — which do you like most right now?
CC: You have to pick your spots carefully, but European CLOs do represent good value. And, for the cohort of European CLOs I’m referring to, typically you will see cleaner, better-quality credit. Yes, Europe is characterised by more concentrated portfolios, lower diversity scores — but at the same time, in many cases they have better subordination [than US deals].
Also, in most European deals, you will see there is an additional OC test below the single B-rated tranche. So overall, depending on which ones you’re picking, they can represent great value for the equivalent risk that you can pick in today’s market in the US.
