Our experienced CLO fund management team currently manages a single fund with the investment objective of creating attractive risk adjusted returns by investing and actively trading different classes of CLOs, seeking to optimize risk and return in the context of market conditions and macroeconomic risk factors. The fund seeks to employ a fundamentals-based, relative value framework in constructing a portfolio primarily focused on exploiting market inefficiencies in CLOs.
In our managed accounts we pride ourselves in ramping up buy-and-hold strategies that give specific exposure to risk that our clients seek. Our clients benefit from access to a club market, where real opportunities are available to a limited number of large and sophisticated investors. Over the years, we have positioned ourselves to source investment opportunities from (distressed) sellers as well as nurtured a strong relation with the street where we get first and last looks, strong allocations and “clean-up” trades. We are proud of our strong execution capabilities in the secondary market which are instrumental in making any good strategy a reality.
What is a CLO?
Short definition of a CLO
A Collateralized Loan Obligation (CLO) is an investment vehicle with a structure similar to that of a standard balance sheet.
On the assets side, there is a portfolio of mainly senior secured loans. This portfolio is actively managed by an asset manager according to the investment criteria stipulated in the deal’s prospectus. During the reinvestment period (typically 4-5 years since the deal’s inception) the manager is usually trading the loan portfolio actively whereas after the reinvestment period the trading is stricter as the proceeds received from maturing loans are paid back to investors according to the priority of payments set out in the prospectus.
A typical European CLO will hold 100 different loans made to sub-investment-grade corporate borrowers (typically rated BB and single B; often referred to as “leveraged loans”). Leveraged loans are typically senior-secured and provided by a group of lenders (banks, finance companies and institutional investors) known as a syndicate, and are structured, arranged and administered by one or more banks, known as arrangers. Most are cash-flow loans which are secured by collateral but paid out of borrower cash flows.
In addition to senior-secured loans, the portfolio can sometimes consist of unsecured bonds or second lien or mezzanine loans. However, the deal’s documents usually restrict the portfolio manager to a cap on such investments.
The collateral in a typical European CLO is well diversified as the collateral quality tests limit the portfolio manager from taking concentrated positions or industries.
On the right side of the balance sheet, the investment vehicle issues liabilities that are rated by the large rating agencies (rated debt securities) as well as equity (Subordinated class). Distribution of interest and principal on the liabilities are determined by a transaction-specific waterfall, with higher-rated tranches having a more senior claim on available funds than subordinated tranches.
Coupon and principal payments on the liabilities (the CLO notes) are paid with the proceeds received from the coupon and principal payments of the assets (the loans), while the equity tranche is being paid from residual cash flows. The equity investors can control important aspects of the CLO vehicle such as callability and refinancing of the liabilities.
For CLO tranches to get higher ratings than the underlying assets, the rated debt tranches investors have several structural protections built-in, including cash-diversion tests, excess spread and credit enhancement. Credit enhancement (C/E) is essentially how much the portfolio’s par value can decline before a specific debt tranche begins taking a principal loss. Even though cumulative losses have exceeded lower mezz C/E levels, the structural protections in the CLO documentation have kept default rates for these CLO tranches low.
ISP CLO Opportunity Fund
Our CLO team is managing the portfolio of a CLO Opportunity fund based in Luxembourg. The fund is restricted to qualified investors and is tailored to exploit inefficiencies in the European CLO market, especially in volatile and distressed periods.
The initial strategy involves a combination of more senior and junior CLO tranches with the objective of minimising risk to capital deployed whilst maximising the potential upside. To achieve this we aim to build a portfolio around discounted AAA-A where pricing has been significantly discounted recently and to add deep mezzanine tranches at opportunistic levels and short duration but riskier equity with high cash on cash distributions. The team continuously reassess exit points to realize profit and roll to new opportunistic trade. During this volatile market we can lock interesting yields from the higher quality assets, allowing us more room to take risk when distressed sellers come to market with riskier assets.
For more details please refer to our dedicated sales personnel.
European Asset Backed Securities
Asset Backed Securities (ABS) cover a large and varied asset class that involves securitizing non-corporate asset backed risk. There is no specific limit on the types of assets that can be put into a securitisation and many asset classes have found their way into bespoke deals over time; these include leases for household goods (such as fridges and other white goods), aircraft engines, whole business securitisations to name but a few. However, the vast majority of ABS securitisations involve real estate risk in the form of residential mortgages, commercial mortgages, student loans, auto loans and credit card risk and these are considered to be the ‘on the run’ asset classes in the ABS securitisation market.
Similar to CLOs, these securitisations involve the tranching of the liability structure that is backed by the underlying assets. The tranching normally ranges from AAA through to BB in the form of 4-5 tranches; The AAA being the largest at usually around 70-80% of the securitisations and the AA-BB tranches usually comprising around 15-20% of the securitisation with a 5-10% residual tranche which is frequently kept by the issuer.
There is a long history of performance in all types of ABS securitisations, especially in Residential Mortgage Backed Securitisation (RMBS) in European core countries. During the 2008-2009 crises all asset classes became significantly impaired including RMBS. However, most of the ‘pre-crisis’ securitisations have since recovered and a good number are still in place today in a state where they have significantly de-levered. Few of the lowest rated tranches still show substantial impairment.