HY fund is exception to rule of CLOs

Fair Oaks Capital has been a long-time advocate of the control CLO equity strategy. Miguel Ramos Fuentenebro, partner at the firm, says the benefits shone through in 2021. “Investing in control equity means you can have a dialogue with the manager to decide key parameters while ensuring the portfolio and structure reflects your view as equity holders,” he says. “We have done deals with short non-call periods in 2020 for example, to maximise optionality.”

“The CLOs in the fund tend to have a lower spread than the market and more conservative portfolios. Applying appropriate assumptions to these portfolios supports attractive returns while facilitating future optimisation via, for example, resets,” he says. “It’s not all about aggressively high portfolio spread and a couple of high distributions, followed by potential pain.”

Olivier Gozlan, portfolio manager at Crystal Funds, says he attributes his CLO fund’s success last year to three factors. “2021 was a stronger year, supported by price and new entrants in CLOs (both on the sell side and buy side), which provided some liquidity. We also had intensive trading activity.” Gozlan adds that Crystal sacrificed some liquidity and looked for yield if the team were comfortable with fundamentals and credit analysis.

Reorg equity in CLOs was also a theme in 2021. US CLOs could hold non-loan assets following the Volcker rule amendments in October 2020. Debdeep Maji, senior managing director at Oxford Funds, says his firm targeted CLOs that used this flexibility.

Serone, meanwhile, was one of two distressed managers in the top 10. Ralph Herrgott, head of special situations, attributes performance to an ‘event-rich’ year, with event-driven or hedged trades contributing to 69% of returns. Synergies with the firm’s CLO strategies and trading within the fund’s portfolio (turnover and volume of 128% and 257%, respectively) also helped, he says.

Stamatia Hagenstein, portfolio manager at Lupus Alpha, says the CLO arbitrage could benefit deals with locked liabilities that are still in their reinvestment period and are able to invest into wider asset spreads. “We saw this in our CLO fund after the financial crisis, where the spread of the underlying assets jumped from 250bp to 450bp,” she says. “We don’t expect this to happen now, but if you are able to increase asset spreads from 10-25bp, it will have a beneficial impact on equity prices and cash outs.”

Maji expects to see opportunities in the CLO secondary market in 2022. “It’s been an interesting year so far in our market because until recently, loan prices were relatively strong despite the overall backdrop of the high yield and the equity markets,” he says. “Because of that dynamic, we’ve seen certain CLO equity profiles trading in the secondary market well below their liquidation NAVs, and we’ve managed to source a few interesting control blocks.”

Herrgott agrees. “The monetary policy stance and rising input cost environment will likely lead to dispersion in the Euro HY market,” he says. He expects to see mis-pricings and a “balanced event set between re-financings, M&A and restructuring”.