Global credit funds & CLO's
August 2020
| Issue 226
Published in London & New York.
Copyright Creditflux. All rights reserved. Check our Privacy Policy and our Terms of Use.
credit derivatives
The surge in index tranche trading has resulted in a deep, liquid and nuanced set of market dynamics
August 2020 | Issue 226
With the ending of lockdown in Wales last month I rolled back the bottle mountain by my front door and exited the bunker, eager to see what had become of the outside world.
Squinting at the sun and mastering the aspect of a grizzled sea captain, I trundled into town with rising trepidation. Something about this first foray made me think of Epimenides of Knossos, who followed a sheep into a cave (a story every Welshman can relate to) only to fall asleep and wake up 57 years later. US readers may recognise this as the Rip Van Winkle story, but the questions are the same whoever emerges: what has changed? Who is now running the show?
What is disconcerting about our post-lockdown situation is the nagging suspicion that everything has changed even though on the surface it all looks much the same.
Share this article:
quotation mark
Welshcake emerges from his bunker to find CLOs still standing and the CSO market getting back to business
I told you CLOs were robust
Credit markets are a case in point. There is substantial normalisation of spreads, portfolios are returning to positive territory, CLO over-collateralisation test breaches are on the retreat and — with the exception of US high yield — there have been few defaults. But we also know there are interventional forces at work with distorting lenses to maintain this comforting facade.
What have we discovered during lockdown? Firstly, that CLOs are not an illiquid asset class, as shown by record levels of secondary trading during the months of the market’s biggest ever test.
Secondly, it is now clearer than ever that there is a big difference between CLO managers, so it’s important to choose the right ones. Check out the latest
CLO equity payment analysis
if you want clues.
A corollary to this point is that consolidation must come and it is no bad thing. We can empathise with new managers that were just getting going when the first wave hit and hope that some good ones have done enough to survive. But promoting a general principle of greater investor discernment — which will result in a concentrated, high-quality set of experienced managers — will guard the industry from accusations of frothiness.
Thirdly, CLOs have proved robust products that act as a mechanism for wider market stability. Government and central bank interventions have done a lot to keep corporate borrowers afloat during the past few months, but CLOs also need some recognition. The picture would be far bleaker if all that debt had been held in more nervous or trigger-happy hands.
I know I’m preaching to the converted with these observations, but most people in the CLO community should feel they have something to crow about. However, what CLO people may have overlooked is that another structured credit asset class has had an even more positive experience. I was worried about how synthetic bespoke investors would get hammered when the March downturn began, but the ensuing months have been a massive vote of confidence for CDS strategies.
There have no doubt been CSO casualties, and they may forever serve as warning against reaching too hard for yield and leverage. But the message from the primary market is that most were astute and are ready to jump back in. New CSO deals have been printed in recent weeks, with debut investors joining the established pack at a better entry point than existed last year.
Exciting times in synthetics
Add to this a surge in index tranche trading — with a particular boost for European business — and the resulting picture is of a deep, liquid and nuanced set of market dynamics. These are exciting developments and they should give even more impetus for CLO investors to embrace their synthetic sister products.
Personally, lockdown has been a time of reflection, of reading and caterwauling. My biggest inspiration has been Cardiff university student Bedwyr Ab Ion Thomas, who has been inventing Welsh words for medical terms so he could carry out his research into fatal diseases in the beautiful mother tongue. There’s no word yet from Isda on my suggestion to update credit derivative definitions and credit support annexes in Welsh. But it would certainly solve the collateralised-something stigma of CSOs if you renamed them “rhwymedigaeth dyled gyfochrog synthetig”.
Share this report: