Whenever it comes to the due diligence of CLO Managers, it’s not uncommon to find that each investor has a somewhat different list of ‘approved’ managers—this diversity makes the market more interesting. Many factors must be considered.
The due diligence list is extensive, with some examples provided below:
Company and Organizational Structure
- History, ownership, and organizational structure
- Experience in managing CLOs
- Trends and breakdowns in AUMs (Assets Under Management)
- Commitment to the CLO business
- Team structure, including reporting lines
- Changes in senior management and staff turnover rates
- Credit experience of the Portfolio Managers (PMs), credit analysts, and the number of credits per analyst.
- Are the credit analysts dedicated solely to the CLO platform?
- Number of years with the company
- Management of key person risk
Investment Philosophy and Investment Committee Approval Process
- Description of the manager’s investment philosophy
- Detailed account of the manager’s investment process
- In-depth explanation of the manager’s credit committee process
- Who, when, what, how
- Understand whether the committee generally takes a consensus approach where every member has an equal say, or if key senior figures dominate the decision-making process
- Determine who has the final say in investment decisions. Is it a consensus decision, or does the Portfolio Manager (PM) make the final call?
- Relationship between analysts and PMs
- Resources and legal support available to analysts
- Contingency plans for managing the CLOs in the absence of the lead PM
- Inclusion of ESG factors
What to Look Out For?
Generally speaking, a very good starting point is a low turnover at the senior management level, a sizeable and experienced credit research team, and long-standing collaborations between experienced senior Portfolio Managers (PMs) and senior credit analysts.
A common observation is that a consensus, team-oriented approach is widely adopted among CLO managers. This approach helps instill discipline when it comes to the approval of credit investments. PMs generally have more discretion when dealing with the buying and selling of approved credits
Conflicts of Interests
- How are the interests of Limited Partners (LPs), Risk Retention Funds, majority equity investors, minority equity investors and the various rating categories of debt holders balanced?
- Dynamics between the different credit groups (reporting lines for the PMs)
- Dynamics between the loan and structured credit platforms
Discussion of Individual Credits with the CLO Manager
- This could provide further insights into the manager’s approach to selecting and managing credit risk.
- One common limitation is that CLO investors may not possess sufficient credit knowledge due to a lack of information, time, or expertise
- Successfully analyzing a few credits will not necessarily provide a comprehensive view of the manager’s performance
CLO Manager’s Investment Performance
- Equity IRRs of all redeemed post-2012 CLOs
- Estimated IRRs for deals expected to be redeemed
- It’s essential to understand the limitations of each performance metric used to evaluate manager performance.
- How can you determine if a manager is inclined toward debt, equity, or has adopted a well-balanced approach? How does the performance of managers fare in light of the numerous outstanding deals that remain unredeemed? These questions find their answers in our individual manager performance reports. These reports employ our proprietary performance attribution analysis to provide a comprehensive resolution.
Other Areas: Controls, Operations, and Technology
The due diligence list could be endless. The objective of dedicating many hours to due diligence is to select a manager who not only performs well but also does so consistently. A proven track record of delivering strong investment performance—not merely presenting compelling deal metrics—is key.
Deal metrics such as CLO equity annualized cash flows, weighted average rating factor (WARF), weighted average spread (WAS), par build/burn numbers, annual default rates, CCC buckets, and other metrics are often used to gauge the performance of managers. While these deal metrics—along with other market value-related metrics like MVOC—are useful, they have their limitations. In other words, relying solely on these metrics risks misjudging a manager’s performance if one does not fully understand their shortcomings.
At CLO Research, we emphasize the use of ‘investment alpha‘ as a measure for evaluating the investment track record of CLO managers. This robust metric captures a range of factors, including interest generation, par build/burn, mark-to-market volatility, credit losses, and both realized and unrealized trading gains and losses. It also accounts for cash drag. Importantly, investment alpha is generally unbiased by the timing of a deal’s issuance, which alleviates concerns about cohort issues.
Related articles:
League Table: US CLO Manager AUM (as of 30 June 2023)
Latest League Table: EU CLO Manager AUM (as of 30 June 2023)
Assessing the Performance of Equity Tranches in Reset US CLO Deals (Updated)
Assessing the Performance of Equity Tranches in Reset EU CLO Deals (Updated)
Some Reflections on the Drivers of 1.0 US CLO Equity Outperformance
Final Post-2012 US CLO Equity IRRs: NAV vs. Annual Distributions and Managers with Over 12.0% IRR
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 of their 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.
