CLO - Securitised corporate loans with an impressive risk-return profile
Corporate loans bundled together and securitised have several advantageous characteristics. Your Alegra ABS I fund invests in CLOs and is 20 years old at the end of July 2024. What makes you invest in loan securitisations for so long?
Daniel Riediker: I could give a very long answer here. But at the end of the day, we have achieved long-term returns with manageable credit risks that outperform equity indices: The fund has a 20-year average return of over 9.4 % p.a.
That is indeed impressive. But weren't these instruments the trigger for the financial crisis?
DR: Interestingly, this is in the minds of most investors, who lump all securitisations together. The triggers were indeed securitisations in the USA, but these had nothing in common with what we are doing. Bad loans (subordinated mortgages) were securitised without any transparency. We only invest in instruments that are completely transparent: We know which loans are in which securitisation. So you can't generalise and say that all securitisations are bad.
But your fund also suffered major setbacks during the financial crisis. Didn't you have any concerns?
DR: Many instruments suffered major setbacks at the time, and we were also affected in terms of market value. The nice thing about these instruments is that we can calculate very precisely how many loan defaults have to occur before we lose money. This is a fundamental advantage and difference compared to equities: loans have to be repaid at par. So when they analyse the instruments, they have to take some parameters into account, but in essence they are estimating whether we will run into such a bad recession that the securitisation will be put at risk by the number of defaults. Each CLO (collateralised loan obligation) is broadly diversified and actively managed. A single default does not disrupt the transaction. This helped enormously: our fund recovered to new highs within two years of the financial crisis, for example, which was faster than most others and showed us how robust these instruments are.
That sounds too good to be true!
DR: We're not the only ones saying that. S&P and other rating agencies analyse the default rates for securitisations very closely. They always come to the same conclusion: CLOs have had massively lower defaults than all other fixed-income sectors in the last 25 years since these instruments have existed in Europe.
Fine, but then why are your returns so good?
DR: The underlying loans of the CLOs have sub-investment grade ratings. These loans have similar spreads to high yield bonds, but generally have better collateral. The big difference to many high-yield bonds is that the loans have a deliberately low rating: The owners of these borrowers, large private equity firms, like to finance their companies in order to improve their own returns. As a result, the credit margins are also higher. If such a company then has a problem, it is often the case that the owners protect their own investment, which is often worth billions, and take measures to ensure that the loan does not default. Otherwise they would lose control of the company and would have to write off their own investment.
In addition, the market for CLOs - we are talking about around EUR 300 billion in Europe and USD 1000 billion in the USA - is relatively small and specialised. These market participants want to be compensated for their analysis and receive a liquidity premium.
So your funds invest in very illiquid assets?
DR: That's a myth. We can usually trade ticket sizes of between EUR 3 and 5 million on the secondary market within 48 hours. Liquidity is usually there, only the price is sometimes significantly below the value. The Alegra ABS I fund has a redemption period of 90 days to the end of the month. The fact that this fund was practically the only one in this area that was open at all times, even during the financial crisis, shows that we probably have the right redemption periods.
The performance of your funds has been very good in recent months, is it worth getting into them at all?
DR: I am often confronted with this question. On the one hand, we have had some catching up to do since corona. On the other hand, the higher interest rates have helped, as our investments have variable interest rates. Yields in the investment grade segment in EUR have fallen from over 9.5 % to around 6.5 % since last November - but show me an investment in the IG (investment grade) segment that yields better. In Alegra ABS I, where we have the riskier positions, we are still seeing extremely high cash flows on the CLO equity positions in the range of 25 % to over 30 % p.a. I therefore do not believe that the market is exhausted. But as with all investments, it sometimes makes sense to enter the market in stages over a certain period of time.
Thank you for your answers. One last question: Are you invested in your own products yourself?
DR: Gladly. And yes, partners and board members have a substantial commitment in their own products: We believe in what we say.
