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Opinion CLOs
The size of a manager says little about how it decides on difficult trade-offs
by Dagmara Michalczuk
Dagmara Michalczuk
Co-chief investment officer
Tetragon Credit Partners
Portfolio manager incentives and MVOC volatility are crucial factors for CLO equity investors
CLO manager selection has traditionally relied on a familiar set of heuristics: AUM, years in the market, team size, historical losses, credit and structural soundness metrics and vintage-level performance, to name a few. While this data is readily available and concrete in investment committee discussions, it is noisy and increasingly insufficient for equity and mezzanine debt investors where the stakes of these choices are higher than for more risk-remote, senior debt investors.
CLO equity returns are highly path-dependent — each decision shapes the deal’s trajectory, influencing both its status and future optionality. Track records tend to simplify these paths into average statistics, obscuring the specific choices that drove performance.
CLO AUM and recent issuance volumes, often treated as proxies for quality, can be particularly misleading. In practice, performance and consistency of results vary among any cohort. Additionally, issuance activity may be more reflective of captive or affiliated equity capital availability, rather than management quality.
Agility is a key consideration
Large platforms may optimise for franchise stability and growth: protecting liability market access and leveraging credit views across the platform with high overlap across deals. Those objectives are rational, but they can shape behaviour in ways that are suboptimal for finite-life CLO equity. Scale can also limit a manager’s ability to quickly reposition portfolios. Large loan exposures and credit committee or restructuring restrictions, can all hurt flexibility. This can introduce organisational inertia and liquidity risks to performance.
Small platforms exhibit a wide range of historical performance records. They can be nimble and entrepreneurial as individual deal performance is critical for them, given a smaller asset base. Platforms which are small because they are new tend to also face expensive liability pricing, which is a drag on their equity returns. The point is not that scale is good or bad. It is that these attributes say little about how a manager will behave when faced with difficult trade-offs.
The implication for CLO investors is clear: manager due diligence must evolve. Simplifying heuristics are useful as initial filters and mental shortcuts, given limited time and often incomplete information. They should not, however, replace a comprehensive manager selection framework. Equity investors should seek to understand a manager’s organisational structure, loss-realisation strategies and decision-making processes.
Incentive alignment is another crucial factor that can provide more insight than historical performance alone. Investors may benefit from evaluating how investment professionals are compensated, how success is measured internally, and whether key decision makers have meaningful economic exposure to individual deal outcomes. This analysis is ideally dynamic, recognising that strategies, ownership and teams evolve over time.
BB-rated tranche market value overcollateralisation (MVOC) volatility can serve as a valuable grading system, offering insights into managers’ behavioural differences. BB-rated debt attachment points are generally more consistent across the market than notional equity tranche leverage, making them more comparable across deals. Additionally, MVOC is highly sensitive to portfolio construction and trading behaviour, making it an effective signal for investors. Its volatility can be tracked over time and benchmarked against market averages or peer groups.
Importantly, MVOC volatility has real consequences for CLO investors. Prolonged MVOC pressure can limit reinvestment and trading flexibility, potentially forcing suboptimal decisions. A manager’s approach to managing MVOC can reveal more about their behaviour and decision-making than their default statistics.
Understanding how decisions are made
While quantitative performance metrics provide valuable data on manager outcomes, they only reflect the results of past decisions — not the underlying processes, incentives and constraints that drove them. These metrics should be supplemented with qualitative analysis to create a more comprehensive picture. In this case, the phrase “lies, damned lies, and statistics”, attributed to Mark Twain, serves as a fitting reminder to look beyond the numbers.
