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News
Equity funds keep CLO market active even as arb thins
by Lisa Lee
CLO managers are raising equity capital to back their own issuance, and the surge is transforming the market.
Oak Hill Advisors closed a USD 1.1bn CLO equity fund to primarily support its deals. CVC Capital Partners drummed up more than USD 700m for its latest CLO captive equity fund, nearing its USD 750m target. And a host of others have raised or are in the process of raising captive equity.
“Captive CLO equity funds have impacted the market by enabling stable issuance even when primary arbitrage is thin,” said Joseph Kupka, portfolio manager at Oxford Funds. “This dynamic creates technical support for loan prices, while simultaneously pressuring CLO liability spreads wider to clear the steady supply of new paper.”
These funds may be the main reason August deal activity ended up at near-historic highs for what was once considered a vacation month — and why a collapse of the arbitrage hasn’t curtailed issuance at all.
They hurt the returns of the asset class
Dan Ko
Portfolio manager
Eagle Point
“What we’re seeing today is that the CLO market has been slower to respond to loan spreads tightening. You could attribute part of that to the amount of captive equity. There are a lot of committed equity dollars compared to third-party equity, which is more discretionary in nature,” said David Kim, head of US leveraged credit at Polus Capital Management. “We would have seen more of a slowdown, but this also happens to be the year in which the 2022-23 vintages are coming out of non-call periods.”
Some fault captive equity funds for incentivising CLO managers to issue uneconomic deals in order to nab management fee streams. Investors in these deals — pension funds, sovereign wealth funds, endowments and family offices — want to see their capital called.
“Overall, there is less discipline from captive funds on CLO equity returns,” said Dan Ko, portfolio manager at Eagle Point. “They help the CLO market grow, but they hurt the returns of the asset class.”
On the other side, many argue investors make too much of the arb at deal creation. “Day one arb has little correlation to ultimate CLO equity returns,” said Scott Macklin, head of US leveraged finance at Obra Capital. What matters, he added, is volatility after a CLO is issued.
Balance may be returning. US CLO spreads are higher than before the April volatility, but they appear to be responding to the massive repricings of leveraged loans.
“We see a major surge in issuance coming in September,” said Steve Baker, global head of CLO primary at JPMorgan.
