Early CLO investors start to reap rewards

CLO investors that entered the market before the fierce summer spread rally are now beginning to reap the rewards.Blackstone Group, Pearl Diver Capital and Sankaty Advisors are examples of funds in the space that appear to have timed their investments well.

For example, Pearl Diver Capital’s US$150m CLO fund – which invests in mezzanine and equity pieces of CLOs – has recorded a NAV growth of 88% in less than a year. The firm now plans to launch two new funds.

The first will focus on triple-A to single-A CLO tranches (original ratings) and, unlike the firm’s current fund, it will be open-ended and more trading-based – making it more suited to hedge funds of funds. It could also potentially invest
in ABS.

The second fund that Pearl Diver Capital is hoping to launch is similar to its current CLO fund (i.e. mezzanine and equity CLO tranches), but would have a return target in the twenties, rather than in the thirties that its current fund offers.

“The fund’s investment decisions are based on fundamental analysis, so while we were confident that the portfolio would perform, the speed at which the CLO market has recovered meant we got our returns at an earlier date than expected,” says Neil Basu, managing partner at Pearl Diver Capital. “Since June, fundamentals have been improving: there’s been a dialling down of loan defaults, the migration of loans to triple-C has slowed and loan prices have increased. The US refi market has also re-opened, so the fear that many CLOs would hit the wall in terms of refinancing has dissipated somewhat.”

September set a record for CLO trading, with close to US$2.5bn in public BWICs, bringing the total amount of public BWICs since late April to over US$8bn when the successful liquidation of Whistlejacket SIV jump-started the secondary CLO market. According to structured credit strategists at Citi, several factors have contributed to the September volumes.

“Anecdotal evidence suggests that workout groups in some banks were looking to offload senior CLO tranches into the rally, although the exact volume that actually traded remains unclear,” they note. “The volume has also been helped further by the liquidation of Victoria SIV, even if just a fraction of the SIV’s CLO portfolio traded in the open market. Finally, we saw a number of bid lists, which we believe were originated by hedge funds that snapped bonds early in the rally and are now looking to lock in profits.”