‘The CLO equity entry point does look more attractive’

Mark Shohet: Essentially, I would say the market has got very good at looking through some of the noise, whether it’s geopolitics, idiosyncratic credit events or industry issues.

You have a bifurcated market. In loans, the high-quality stuff that everyone wants is trading at par or par-plus, whereas the larger ETF names or those under pressure — industries such as software or chemicals — are not trading well, and they don’t have anywhere close to that kind of technical support.

Despite geopolitical tensions and elevated oil prices, we’re still seeing model portfolios go tighter, because everyone’s chasing the same good assets.

So my glass-half-full view on the market is that technicals are firm. People don’t want to be left without high-quality paper. There isn’t a real desire to sell, because it’ll be hard to replace.

But I think on the flip side, my glass-half-empty view would be that the market is potentially being complacent. We are at risk of a sell-off if the technicals turn quickly and if there are unexpected events, whether in the Middle East or even here domestically [in the US].

MS: Across the firm, and particularly within our CLOs, we have exited things that are just simple coding businesses or anything that can’t get to 4-5x leverage. We have exited because we do have that fear that software could become a utility.

Where we’re more positive is in areas where any existing large enterprise software could have AI tools sitting on top of that software, because we don’t think CEOs are going to risk incumbent data and software to use AI bots, at least not anytime soon.

I do have concerns with the fact that if you look across the CLO universe, many managers haven’t cut software in a meaningful way. It’s been on the margin. We’ve got maybe 30 or 40 basis points of reduction on the median CLO. That is not taking a view that there’s going to be significant AI disruption.

Away from software specifically, a lot of the tail assets and loans trading below 80 or even between 80 and 90 — they’ve been there a long time. These names are well-known. I don’t think you’re going to have the kind of pull-to-par experience that may have been traditionally expected. So I do think there will be elevated defaults in certain equity profiles, and some debt will be impaired.

MS: There’s obvious relative value in CLO IG. We should consider higher-for-longer rates, which can be a good environment for CLO IG. So I think it’s attractive to corporates. I think on sub-IG, it’s probably too firm. I don’t think you’re pricing in any kind of material downside risk in current levels. So we’re not playing those in a meaningful way.

CF: This is a weird market because you have software disruption, but the rest of the market is doing so well. What is your take on CLO equity right now?

MS: Because equity has taken some pain, particularly in the secondary market, it has repriced to the point where the entry point does look more attractive than in the last 12-18 months. It still looks relatively tight, but if you have a view that we are going to have more meaningful volatility and sell off the loans, then it could be a good time to buy.

CF: We’re hearing of a lot more CLO managers who are looking to launch, particularly in Europe. How do you do due diligence on that many prospects?

MS: The simple answer is, you can’t. But in general, when assessing new managers, you want to understand the incentive structure, the CLO equity support, that they’re going to be issuing frequently enough, and the depth of the analyst pool.

If it’s a manager that you like, but the primary spreads are only 5-10 bps wider than a tier-1 manager or a liquid manager, I don’t think that’s worthwhile.