CLOs are making a come-back, having received a largely undeserved bad rap through the global financial crisis. An under-appreciated fact is that they, on average, didn’t lose any money in the crisis. They came back to par. They are now shining in a low-yield environment.
CLOs (collateralised loan obligations) make up nearly all of the portfolios run by Alcentra’s structured credit team, amounting to $US6.6 billion (as of December last) globally. The firm, founded in 2002, has a total of US$41.1 billion under management and is an affiliate of BNY Mellon Investment Management. Cathy Bevan, an Alcentra managing director and portfolio manager for structured credit – head of the structured credit team in Europe – visited Australia last week to speak at a conference and talk to clients and advisors.
She said: “One of the benefits of CLOs is that you can pick your spot in terms of how much risk you’re prepared to take for how much likely return. For instance, in AAA-rated ‘CLO debt’ portfolios, you can get the LIBOR index plus 100bps. In ‘CLO equity’, you can get double-digit returns.” And then, as a point of differentiation from its funds management competitors, Alcentra also invests in ‘CLO Warehouses’ which are a tactical asset sub-class of a short-term nature, which can also deliver outsized returns. They are usually recommended only for sophisticated investors.
She said that structured credit, such as CLOs, offered a compelling opportunity, especially in the current environment. It was a floating-rate income strategy with low duration risk. Advantages in the CLO debt portfolios included: higher return potential than corporate debt, with downside protection; advantages in CLO equity portfolios included outsized return potential from, predominantly, senior secured assets, currently high cash yields, and access to competitive non-recourse financing; and, for CLO ‘warehouses’, outsized return potential coupled with the ability to roll into CLO equity at preferential terms and consisting of a short-term trade with relatively low volatility.
She says that CLOs have been “tainted” by the experience investors had with ‘CDOs’ and sub-prime debt during the financial crisis. “No-one had ever seen these go through a credit cycle before,” she said. “CLOs have a safety-valve feature, which is an over-collateralisation test. If the portfolio deteriorates it automatically captures cash. The CLO is a lender of record. It owns the loans. It’s a cashflow structure and not a derivative… It’s a curing mechanism to deliver… outcomes which have been very good for debt holders.”
Bevan invests “a lot” of her personal money in Alcentra’s structured credit strategies, because they have offered higher yields than bonds. The firm offers considerable flexibility options for risk/return exposures. Approximately 50 per cent of its structured credit funds under management represent customised mandates for big investors.
In its Structured Credit Opportunities strategy, the firm has often allocated to Europe over the US, although it is not averse to allocating up to 100 per cent to either of the two main geographic centres for these securities. Most recently, it has added more to the US due to market conditions.
“The key message for relative value is to look through to the underlying collateral [in the securities],” Bevan says.
The global head of structured credit for Alcentra is Hiram Hamilton, who joined the firm in 2008, launching the first opportunistic fund towards the end of the crisis in 2009. He was previously the head of Morgan Stanley’s structuring and origination business in London.
Cathy Bevan joined the firm in 2012, having worked as part of Citigroup’s structured credit team previously. She was in Australia as a sponsor of, and speaker at, a Conexus Financial conference in Melbourne on the subject.
– G.B.
