Phil Raciti, head of performing credit and a portfolio manager at Bardin Hill, explains the key attributes needed to be successful as a CLO manager

The CLO asset class operates within a sophisticated construct of arbitrage, leverage, and structural protections. Having navigated multiple recessions and the most significant period of issuer downgrade activity on record in 2020, the asset class has time and again emerged as a proven equilibrium of investment complexity and an elegant structural architecture.

In the current environment of earnings growth and low defaults – when equity returns are as strong as NAVs are high – it is more important than ever that CLO managers focus on efficiency. Well-researched investment theses and ongoing credit monitoring designed to offset embedded asymmetric risk of underlying CLO assets are fundamentals, but even the most sound credit processes will lead to some asset loss that was unprotected by the CLO structure. At Bardin Hill, we have built efficiencies in processes, communication, and systems to differentiate ourselves and strengthen our decision-making, all of which helps us drive performance.

As a long-tenured manager of CLOs of varied structures, asset characteristics, and liability execution, I leverage extensive experience as I construct and manage our portfolios, with a continual eye on efficiency.

All strategies executed by CLO managers are public. Every month, reams of data are distributed to investors detailing every trade, rating change, and basis point of risk movement. The data is parsed and analysed via public data feeds, with manager-style guides setting up monthly performance contests. There is no hiding as a CLO manager, as marks are current, mistakes emerge, and beauty contests are constant.

As such, a CLO manager must navigate a series of structural restrictions while utilising a limited playbook of tools to defend against potentially conflicting interests on behalf of investors. This structural burden is offset by the benefits of limited mark-to-market triggers and leverage driven returns. In all, the structures represent a fair compromise of logic and leverage that provides investors with a significant level of investment protection and transparency, while aiming to drive enhanced returns.

Embracing this level of transparency, a CLO manager is in the best position to understand underlying market conditions, drive foresight into future risk strategies, and hedge through positioning as system-wide risk builds. Transparency of the asset class, coupled with enhanced tools for large dataset analysis, is key to driving improved outcomes in CLO investing. At Bardin Hill we gain unique insight into competitor activity and can adjust positioning by utilising large analytical databases to construct CLO manager health dashboards, assisting us in our drive to make more informed decisions and allow us to better project future market conditions.

Active planning, hypothetical analysis, and preemptive trading are hallmarks of an efficient CLO manager. Foresight and active management, both in the traditional risk management sense and as a CLO technician, are equally important in terms of efficiency.

An efficient CLO manager predicts not only future market conditions, but also future CLO manager behavior, structural limitations, and rating agency sentiment. The manager considers when and how to lean into markets while maintaining enough structural cushion to risk position. The manager also utilises the CLO structure to drive returns and never allows the CLO structure to dictate risk management.