In the CLO market, investors are welcoming new deals formed with exposure to industries hit by coronavirus fallout.

“CLO managers should demonstrate conviction,” says Laila Kollmorgen, CLO tranche portfolio manager at PineBridge Investments. She says that the strength of this conviction should be mirrored in CLO portfolios and that PineBridge is willing to back managers if their investment thesis aligns with PineBridge’s.

“Weighting credits appropriately has always been important. I like to hear: ‘We don’t have too much conviction on this name, so we’re limiting exposure to 25 or 50 basis points,’” she says.

Theme park operator Merlin Entertainments is a global firm in the entertainment industry and has therefore suffered amid social-distancing rules. It is a prime example, however, of a firm that is in favour among CLO managers, with CLO-i data showing it has been heavily traded — both buys and sells — in September.

“Leisure companies like Merlin are in new CLOs and go to show that managers are digging into fundamentals,” says Los Angeles-based Kollmorgen. “With different levels of lockdown, loan performance could become country and location-dependent. Similarly, cruise firms will have different outcomes depending on their routes.”

Kollmorgen says that CLO portfolio construction is also dictated by the fact that loan prices have risen into the high 90s, which makes assembling an entirely clean asset pool difficult for structured credit portfolios that have to consider their liability stack.

Cara Roche, portfolio manager at Zais Group, says that, for those investors that can effectively analyse portfolio tail risk, the best opportunities lie in the secondary CLO market. Part of the reason is that there are full portfolios to examine. Secondary CLO debt tranches also provide better convexity and Roche feels that call scenarios have not been fully priced in.

In the CSO market, a dealer tells Creditflux that new transactions contain credits from covid-affected industries (tight spreads have constrained CSO issuance for some time). “They’re especially prevalent in really short-dated deals,” he says.

New Jersey-based Roche invests across CLOs and CSOs. She points out that CSOs are attractive because first-loss investors can customise risk.

“If you’re comfortable with portfolio tails and you can withstand mark-to-market volatility, then there is a compelling argument for CSO equity,” she says.