There are two ways to live: you can live as if nothing is a miracle; you can live as if everything is a miracle. – Albert Einstein
Assessing CLO Managers’ Investment Performance
Q: Why is the investment alpha used instead of the more readily available CLO deal metrics to assess managers’ performance?
A: Deal metrics such as CLO equity annualised cash flows, weighted average rating factor (WARF), weighted average spread (WAS), par build/burn numbers, annual default rates, CCC bucket and other deal metrics are often used to determine the performance of managers. While these deal metrics (including some other market value related metrics such as MVOC) are useful, they have their limitations. In other words, there is a risk that one may get a wrong sense of a manager’s performance by using these metrics without understanding their shortcomings.
Having said that, as this asset class is becoming more mainstream, managers could be assessed using a complete performance measure such as the traditional alpha measure used for investment funds.
Indeed, CLOs are not MTM loan funds, but the fact of the matter is – CLO tranches are also traded based on their actual underlying portfolio MV and income generation capability. Besides, CLOs rarely mature on their maturity dates, so MTM will kick in at some stage (unless a CLO deal performs so poorly that the deal document does not allow a redemption even when equity cashflows are non-economical).
As managers are paid a fee to manage the loan collateral pool, there is no reason why they should not be assessed against the loan index, so that one knows whether a manager is adding value or not. Are CLOs not seen as an efficient way to gain exposure to the loan market?
The investment alpha is quite a complete measure. It captures interest generation, par build/burn, mark-to-market volatility, credit losses, trading gains and losses (realised and unrealised), cash drag and so on. Additionally, it is typically not biased by the timing of deal issuance in light of market conditions, so one does not need to worry about cohort issues.
Further, it also allows one to compare managers on investment performance more easily and with the broader loan market.
In general, CLO managers who register a good interest return alpha and a decent MV return alpha tend to do well for CLO equity investors. Debt investors would tend to focus more on the MV return alpha. Some managers adopt a conservative style with a lower-spread portfolio strategy but not all do well in terms of MV return alpha.
At CLO Research, research articles on US and EU CLO managers’ alpha metrics (including performance attribution) are published regularly. CLO investors can monitor the investment performance (and performance attribution) of their managers and track how they are doing – including style drift, over time. CLO managers can benchmark their performance (and performance attribution) against the market and peers.
Disclaimers
The information, research, data, research related opinions, observations and estimates contained in this document have been compiled or arrived at by CLO Research Group, based upon sources believed to be reliable and accurate, and in good faith, but in each case without further investigation. None of CLO Research Group or its service providers; authorised personnel, or their directors make any expressed or implied presentation or warranty, nor do any of such persons accept any responsibility or liability as to the accuracy, timeliness, completeness or correctness of such sources and the information, research, data, research related opinions, observations and estimates contained in this document. All information, research, data, research related opinions, observations, and estimates in this document are in draft form as of the date of this document and remain subject to change and amendment without notice. Neither CLO Research Group nor any third-party providers shall be subject to any damages or liability for any errors, omissions, incompleteness or incorrectness of this document. This article is not and should not be construed as an offer, or a solicitation of an offer, to buy or sell securities and shall not be relied upon as a promise or representation regarding the historical or current position or performance of any of the deals or issues mentioned in it.
