I’ll see your 2020 and raise you 2021

“Of all the factors that affect CLO equity performance when structuring a deal, the purchase price of the loans happens to be the most important,” he says. “To illustrate the point, assume an extreme hypothetical situation where an investor can purchase a loan portfolio at 90 cents and issue debt tranches at par. If the leverage is set around 10-times, then the investor would not need any additional equity capital to structure the deal — which makes CLO equity a very low cost option on the loan prices.”

The amount of par created by the rallying loan market meant that when CLO equity investors opted to reset or refinance deals, they had options. They could either flush the principal back to investors to front-load their payments and increase the deal’s internal rate of return (IRR). Or, some of the par flush could be left in the deal to upsize the CLO, creating larger equity payments down the line. This approach is the equivalent of putting in new equity capital for the cost of a reset.

Fortress Investment Group is close behind GoldenTree. It also averaged above 22% annualised, while Fidelity Investments rounded out the top three at 20.54%. Fortress and Fidelity have shot up the table compared to their positions last year, rising from 69th and 80th, respectively.

The firm was able to take advantage of the bond market in its portfolio thanks to having high limits for fixed-rate debt and for bonds. According to Steven Paget, portfolio manager for European performing credit, bond flexibility helps in a number of ways. “Bonds have call protection, meaning you are able to sell above par when the credit performs and/or the market tightens, whereas loans will generally get refinanced when they are above par.” This, he argues, allows managers to build par in a portfolio when bonds are included.

“Additionally, the relative value between the loan and bond markets shifts over time,” says Paget. “Active portfolio management — including selling loans against bonds or bonds against loans, depending on where the value is — can lead to improved performance and par build.”

Lastly, settlement times for bonds are shorter than for loans, meaning the assets settle and pay a coupon into the CLO more quickly, which improves equity payments.

Man GLG and Credit Suisse Asset Management were second and third in highest average annualised payments at 19.43% and 17.87%, respectively. Napier Park had the largest increase from last year’s report, rising from 42nd to 7th. Hayfin was just behind as it increased its standing from 43rd to 10th.

While CLO managers in Europe used bonds and their shorter settlement times to make their deals run more efficiently, US CLO managers increasingly turned to negative cash balances to overcome shortfalls.

Market sources say that the balance of excess traded cash in CLO portfolios went from 0% to -3% on average in the market last year. But this is still only around $15 million on average for a CLO.

Desai says negative cash balances help “the CLO run more efficiently as you’re effectively putting more than a dollar to work. If a new issue loan won’t settle for a month you can remain overinvested on a traded basis in order to increase interest collections and reduce cash drag to the equity.”