Global credit funds & CLO's
November 2020
| Issue 229
Published in London & New York.
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News in brief
November 2020 | Issue 229
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Credit rally slows but structured finance funds gain
Corporate credit spreads levelled off in September, which means that 63% of funds in the
database have just a single quarter left to make it to positive returns for the calendar year.
Structured credit funds did best in Q3, perhaps because these assets tend to lag moves in liquid credit. Serone Capital Management tops our monthly performance tables, gaining 4.1% for one of its strategies.
CIFC, Marathon, Alcentra and Prosperise round out the top five.
CLO funds were up 2.2%, but are still down 10.25% this year, whereas US high yield could only muster 0.7% returns in September against 1% gains year to date.
WTW to tackle lack of diversity across investment industry
Progress on diversity across the investment industry is “disappointingly slow”, according to research from Willis Towers Watson. The investment consultant released a white paper entitled Diversity in the Asset Management Industry, where it has set out an action plan to “accelerate the pace of change”.
The issue of racism has gathered momentum in 2020 campaigns, such as the Black Lives Matter movement, and several investment firms have since declared a commitment to tackling the lack of diversity in leadership positions.
BlackRock made headlines in June by, among other things, committing to double the representation of black professionals in leadership positions and increase overall representation by 30% by 2024. Citi appointed Jane Fraser as the first female chief executive officer of a large bank this year.
WTW suggests several action points, including: greater transparency and disclosure with high-level statistics to understand how diversity is reflected across different functions; increased sourcing of diverse talents, for example, through graduate and returner programmes; measurement of diversity of asset managers beyond equity ownership; the removal of requirements that may unwittingly exclude diverse funds/firms; progressive compensation structures and policies around flexible working arrangements; and a shift away from a “star portfolio manager model” to a team-based investment approach.
WTW itself has said it will use a diversity score to establish a periphery view on gender and ethnic diversity, which will be complemented by the more nuanced aspects of diversity through research.
Investors search out illiquid credit for improved pricing
Credit investors are still trying to gauge appropriate pricing levels for smaller credit facilities in the tradeable credit space.
“Market liquidity continues to be very poor, resulting in less price transparency, particularly in smaller-sized bond and loan tranches and investment grade debt,” says Ted Goldthorpe, partner and head of BC Partners Credit.

“We are finding very few opportunities in liquid credit, but there are good opportunities in off-the-run illiquid credit in non-covid affected sectors, particularly in the middle market,” he says.
At Creditflux’s US Private Credit event last month, panellists said that for larger loans in the middle market, pricing is about 100 basis points wide of March levels, but that gap has been narrowing.
Although primary market deal-flow has improved since June, with private equity sponsors putting capital to work, the direct lending market is still struggling to find clearing levels for more exotic investments and asset classes. Sectors directly affected by covid continue to be difficult to underwrite with conviction around forward projections.
Company financials have been slightly better than many investors expected, but a lot has been driven by expense control verses revenue growth. The combination of revolver drawings and fiscal stimulus initiatives have left companies with decent liquidity positions.
Despite this, defaults are likely to be elevated in the first quarter of next year, according to Goldthorpe.
Start-up CLO manager plugs into hi-tech solutions
Newly-formed US CLO manager Pacific & Plains Capital says it plans to put technology at the heart of its business for a range of purposes including timing of refis and resets.
“There are multiple ways in which we believe technology can give Pacific & Plains an edge,” says Daniel Hall, chief operating officer at Pacific & Plains. “Initially we intend to identify price dislocations in the loan market using quantitative parameters, but in the long term we intend to combine AI and big data to identify micro and macro trends.”
Hall says that in the long term, developments in areas such as quantum computing could be powerful in CLO management as loan market data deepens.
Technology is at the heart of the Dallas-headquartered firm’s plans as it feels it can help reduce operating costs and identify opportunities.
Creditflux reported that the firm, launched by former Ares partners Hall, Shane Mengel and Americo Cascella, is looking to issue its first CLO early next year.
Hall: will initially identify price dislocations via computation
B-wic appearances boost CLO equity valuations
CLO investors who use third-party valuations say that CLO equity may be undervalued.
There has been a normalisation in double B prices (more so in Europe and less in the US due to the larger quality range), but CLO equity tranches are only being revalued with confidence when they trade.
A US CLO equity investor tells Creditflux she finds secondary investments attractive, but the bid-ask spread is wide and sourcing assets is difficult.
Miguel Ramos Fuentenebro, partner at Fair Oaks Capital, says that valuation providers are trying to figure out where equity is pricing. “I don’t think they have enough confidence to say this OC with this reinvestment with this manager is this price,” he says. “If you look at valuation data, we have seen instances where equity that has not traded seems to be lagging. Anything that has traded is, of course, adjusted.”
London-based Fuentenebro says he saw the same challenges play out in 2016 and thereafter made the choice to start publishing valuations on all equity and debt positions held in Fair Oaks’ listed CLO strategy, Fair Oaks Income Fund.
Looking at equity valuations in the vehicle, items that have not traded in the secondary market are valued roughly 5-10 points lower than in March, while items that have appeared on b-wics are valued a good 10-15 points higher than in March.
Fuentenebro says that investors should consider publishing equity valuations. “The reality is that our strategy is difficult to replicate and maximum valuation transparency allows us to have meaningful discussions with shareholders and investors, particularly during volatile times.”
After long retracing, tight IG names offer blow-out potential
A shift wider of credit spreads was underway as Creditflux went to press, giving weight to several weeks of mounting investor concern about how far the market has retraced since the covid sell-off in March/April.
Expectations of a bumpy ride into the end of 2020 have prompted many market participants to consider when to time short positions. As reported in our quarterly Credit Rendezvous supplement, this has mainly focused on placing beta shorts through CDS indices, but some investors’ attention is turning to name-specific short strategies.
Investment grade credit in particular has looked tight in recent weeks and it is this part of the market, led by financial names, that has suffered most in the end of October rout.
The iTraxx Europe CDS index was 13bp out from its 50.5bp local tight on 12 October by time of press, according to IHS Markit, while CDX IG at 63.25bp was 10bp wider than its 9 October tight print. The Senior Financials basket of Europe surged 15bp wider in the same time, reaching 81.5bp.
A close analysis of investment grade on-the-run portfolios, a month old since their roll to new series in September, shows the potential for disparities in how constituents may perform in a sell-off. Dispersion risk is greatest in CDX IG, where 11 companies trade at spreads more than 300bp inside their covid-induced wides of March and April. Of these, General Motors is one of the most extreme: 572bp inside its peak at time of press.
Despite a similar overall index spread, the picture of dispersion in Europe looks less pronounced. Nevertheless, 16 constituents were 140bp or more inside their post-covid wides, with Glencore the extreme at 171bp or 384bp tighter.
The concern — or opportunity — say sources, is that these names have proved liable to underperform if similar conditions to March/April return. Central bank interventions could curb short gains, but some distinction between ‘haves’ and ‘have nots’ is likely.
Low rates drive US pension towards private credit
The Iowa Public Employees’ Retirement System is one of several pensions to have increased private credit allocation recently, from 3% to 8% (around $1.7 billion).
“The issue facing investors is the reduction in interest rates on traditional fixed securities globally,” says Greg Samorajski, chief executive officer of the $34 billion fund. “With a reduction in expected return, our board looked towards options in alternatives. We have a long-term horizon as a defined benefit plan so we can allocate to illiquid assets.”
In October, the pension issued an opportunistic private credit request for proposal, through which it can allocate up to $850 million across one or several managers, depending upon the quality of proposals received. The scope of the mandate includes mezzanine lending, special situations, specialty finance and credit backed by real assets.
The Iowa pension fund has around $750 million allocated to senior US mid-market direct lending, having partnered with BlackRock (Tennenbaum) and Monroe Capital.
Samorajski says the increase in allocation was made to diversify its private credit offering and it has plans for a follow up commercial real estate RFP.
The private credit portfolio aims to return S&P/LSTA Leveraged Loan Index plus 1%, net of fees.
Equity tranche shorts gather for fallen angels
Investor views are starting to form around on-the-run iTraxx and CDX index tranches, following their rolls into new versions at the end of September and start of October.
In particular, CDX IG and iTraxx Europe investment grade portfolios removed several fallen angels and are trading tighter than previous versions. But expectations of resurfacing volatility into the end of the year suggest relative value opportunities could open up as spreads return wider.
“All fallen angels joined HY35 from IG34, so now we have an IG/HY hybrid of IG34 and a much cleaner IG35,” says one New York-based correlation trader. “IG35 tranches came out reflecting much lower dispersion, but the IG34 experience is still fresh and people worry that a prolonged pandemic may cause dispersion again in IG35. Hence, clients have net bought protection on IG 35 0-3%, and sold 3-7% and 15-100%. 7-15% is more balanced.”
Correlation in iTraxx Europe is higher after the roll, notes a London-based portfolio manager. As such, value has moved from the lower part to senior mezzanine tranches. “The riskiest constituent is around 200 basis points, but going long the equity tranche does not make sense at these tight levels,” says the PM.
“Super senior might be crowded or have big guys trading it,” they add. “But since 2004 there have only been two defaults in the Main index — Portugal Telecom and Thomson. So if you go long 6-12% or 12-100% tranches, they are essentially risk-free, while today’s high correlation makes it an interesting entry point.”
Distressed names remain in Crossover and one, Europcar, looked close to triggering a credit event as Creditflux went to press.
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