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Opinion CLOs
Large managers have many advantages. But they don’t hold all the cards
by Thomas Majewski
Thomas Majewski
Founder & managing partner
Eagle Point Credit Management
Acquisitions can lead to style drift as different investment philosophies clash
As the CLO market continues to grow each year, we wonder: is bigger better for CLO investors? Do larger CLO collateral managers outperform because size leads to tighter CLO liability prints? Certainly, the recent growth in M&A activity among credit managers implies a belief in the significance of scale — with access to an increasingly competitive market for assets an added benefit. And it seems likely that the consolidation trend will continue.
Today, investors are increasingly seeking not just returns, but consistent and differentiated sourcing capabilities. For example, in the private credit markets, investors want asset managers which can deliver access to transactions across market cycles and aren’t dependent on intermediaries to source opportunities. This pressure for origination alpha has pushed participants to expand their footprints, either organically or through strategic acquisitions. Large firms generally have broader origination networks and more capacity to provide solutions in big transactions that might be beyond the reach of mid-sized players.
With expansion also comes a more holistic view of the credit markets. Firms that participate in both the broadly syndicated and private credit markets can observe the dynamics of both, allowing them to identify opportunities that might not be apparent to firms that focus on just one.
Bigger firms get preferential terms in LMEs
Then there’s the reality of doing business: bigger firms can dictate better outcomes. While the Serta decision reinforced the importance of the pro rata treatment of lenders, the prevalence of non-pro rata outcomes in liability management exercise (LME) transactions seems only to increase. When borrowers need additional capital or term extensions, those lenders with the deepest pockets often secure preferential terms, sometimes at the expense of smaller participants.
In this environment, being large enough to drive economic terms in restructurings could prove more valuable than the ability to quickly trade in and out of positions. CLO collateral managers are reconsidering their approaches, as poor recovery outcomes can severely impact overall performance metrics and damage their reputations.
In addition, large CLO collateral managers typically enjoy better access to capital during volatile periods, as investors seek the perceived safety of established platforms.
However, as these trends and M&A activity continue, there are a few things investors should consider when organisations grow quickly. Large asset managers may struggle with bureaucracy and slower decision making. Cultural integration following acquisitions can prove challenging and may lead to the departure of key talent.
Scale can also add challenges for credit managers. Acquisitions can lead to style drift as different investment philosophies clash, and the sheer size of combined portfolios can make active portfolio management and nimble trading difficult. Large positions become harder to exit, and overweights are often an unavoidable consequence of managing such substantial pools of capital — try moving USD 300m of a single loan quickly and discreetly.
Evaluate CLO managers beyond size alone
Investors are wise to stay alert as consolidation in the credit manager market continues. Certainly, investors should always look beyond size alone when evaluating CLO collateral managers. The true test will be whether these enlarged platforms can maintain their investment disciplines, preserve their cultures and continue delivering alpha while facing the burdens that come with larger scale.
Of course, as some firms get gobbled up, it is also important to remember that there are usually a handful of new entrants to the CLO collateral manager business each year. Scale and access to assets does not come solely from having a large CLO issuance business. Other relationships and assets are important. So perhaps investing with a new entrant is worth the risk of wider CLO debt liability spreads in return for nimbleness.
