John Kim, Panagram ceo and portfolio manager of CLOZ, answers SCI's questions

Q: What can you tell us about the launch of Panagram’s new actively managed CLO ETF (CLOZ) (SCI 25 January)?
A: We’re very excited about our ETF (CLOZ) because it brings CLO opportunity to the retail market. Ultimately, we are trying to make it easy for retail investors to enjoy the benefits of CLOs that institutional investors have enjoyed for years.

Traditionally, CLOs have been difficult for retail investors to buy because they can’t access these investments directly and if you have a small amount of money, it’s hard to create diversified exposure. We think our ETF is unique because it gives people access to a part of the capital structure in CLOs that isn’t available in other CLO products right now. We believe individual investors will have the potential to achieve attractive risk-adjusted yields in CLOZ. 

The ETF concentrates on triple-B and double-B bonds; 80% of the investment mix will be CLOs rated triple-B and below. In our opinion, this will lead to enhanced risk yields for the underlying investors, especially as CLOs are arguably one of the most attractive risk-adjusted credit assets available to investors.

Q: How is this an effort to democratise CLO exposure?
A: Most CLOs can’t sell a bond or any part of the capital structure directly to an individual investor. The ETF attempts to solve the issue of needing access to the market and a substantial amount of capital to create the diversification, given the bond minimum on CLO bonds. CLOZ can bring diversified exposure with attractive yield to the individual investor, who can trade in one share of the ETF.

Q: What is the vision for Panagram’s business this year?
A: Panagram currently manages US$14.4bn in structured credit assets. Our vision is to continue to scale our expertise in the structured credit space with both institutional and retail investors.

For 2023, we anticipate launching several other funds. We recently filed a prospectus for a closed-end equity fund that will provide investors with diverse exposure to CLO equity.

In addition, we continue to partner with large institutional investors to provide customised access to structured credit in separately managed account format. 

Q: And how does Panagram mitigate the risk of the wider challenges looming over markets in 2023?
A: Inflation, rising rates, geopolitical pressures and recession are all concerning. With rates rising quickly in a short period of time, stress has been placed on some of the companies in our leveraged loan portfolio, as well as generally more stress within the corporate arena. However, we believe there are several attributes to note about CLO exposure that are positive mitigants to these kinds of situations.

First and most importantly, CLOs are primarily built on senior secured corporate loans. If you’re a lender in the capital structure of any company, we would consider it to be more preferable to be senior, first pay and secured by assets than it is to be in high yield bonds, the mezzanine loans or the second lien loans. While the debt service coverage ratios on senior loans have fallen due to the rise in rates, they haven’t yet fallen to a point where we think they are concerning.

It is for some of these reasons that the underlying asset class, senior secured loans, has performed well over the last 30 years. When you’re exposed to loans in a CLO format, you are taking advantage of the seniority and the security and then putting that into a structure that has a further capital cushion if you’re a debt investor. For newly created double-B CLO bonds, investors have approximately 10 points of capital beneath them when they start the deal; and given the structural protections of CLOs that deleverage deals automatically when you encounter a certain amount of portfolio losses.

As a result, there have been few losses at the double-B level. For CLOs rated by S&P, there have been zero defaults at the triple-B level since the GFC. So the structure has proven to work well, and we believe that will continue into the foreseeable future.

Q: How is CLO risk considered at Panagram?
A: Paramount to everything we do at Panagram is assessing risk and looking for ways to mitigate risks in downside scenarios. As it relates to CLOs, we are tracking bond fundamentals and technicals, but, in addition, we are monitoring the senior secured loan fundamentals and technicals.

One of the attractive aspects of the CLO market is the availability of data. We have the ability to track each CLO down to the individual loan level, how much we own, when the loan was purchased, sold, etc.

We are monitoring our loan exposure across multiple deals and with different CLO managers. Our CLO managers are our partners in assessing risk within the loan market.

We have the benefit from where we sit in the CLO ecosystem of having varied loan team perspectives. We value managers that are proactively optimising portfolios and actively trading portfolios to mitigate risk. 

We are currently finding value in triple-B and double-B rated CLOs. In terms of new issue equity, we think the arbitrage is quite challenged at the moment, given that loans have run up in price over the last month and the CLO stack has not tightened sufficiently to make the arbitrage attractive for new issue. However, that is changing rapidly as new issue deals are driving triple-A spreads down, and we think that will lead to more people wanting to securitise their warehouses.

Q: How do you differentiate yourself from your competitors?
A: Our team has expertise and scale in CLO investing. We trade up and down the entire CLO stack - from triple-A down to equity.

We see the market from the perspectives of the senior debt holders, mezzanine debt holders and equity – and that combined knowledge isn’t siloed, because we have one team doing the entire capital stack. So, our view of the market is the attribute that distinguishes us the most in terms of our investing.

When we invest in primary equity, we also tend to run the entire deal. We choose the manager, we do our own structuring and we try to create a deal that’s going to perform for the long term.

We are very selective about the managers we work with, as we work with only around 20 managers of the total 130 or so in the US. We spend a lot of time on manager diligence because these are long-term deals for us – we aren’t in it for short periods of time, so we want to make sure that when we commit capital, we are doing it with the right partners.

As it relates to our CLO ETF, some of our competitors have created CLO ETFs; however, our ETF emphasises investments in triple-B and double-B rated CLOs because we believe this is where the most attractive risk to yield can be found.

Q: With the ongoing evolution of the CLO market, what is your expectation for competition within the market this year?
A: There has been an increase in so-called tiering in the investment markets, as there is now a very clear distinction between managers considered to be tier one and those that are tier two or three. For investors, the amount of data that is available to us is vast, which wasn’t always the case in the market; in the last few years, the challenge has been to interpret the data properly, as there are a lot of metrics that go into these investment decisions.

New managers could be very challenged in this market, given the bifurcation in spreads between tier one and everyone else. When CLO managers perform well, they tend to attract more assets. Newer managers typically raise dedicated funds to launch their platforms before attracting third-party CLO equity investors like Panagram. This dynamic is a tailwind for the market, as it attracts new allocation to the CLO market, typically from new investors.  

Q: Within CLOs, whose burden do you believe dealing with ESG should be?
A: ESG is something that all market participants need to pay attention to, as capital flows can have a direct influence on ESG factors. However, private capital can only create change if it is directed in the right manner.

We follow a three-pronged approach at Panagram – the first being our attempt to influence underlying CLO managers away from certain loans in the markets that our employees identify as being problematic. There are certain ESG-related categories that we encourage our managers to eliminate their exposure to – especially when we are investing in CLO equity in a new issue deal, where we have greater ability to influence the thoughts of those managers.

Our second prong is corporate governance, where we emphasise gender and racial diversity in our hiring process and promote initiatives to train and retain employees of diverse backgrounds. Our third prong is our community engagement – where, for each fund we launch, we plan to donate a portion of the management fees to a local charity. For our CLOZ ETF, we have donated a portion of our fees to Mosholu Montefiore Community Center (MMCC), which provides educational resources and enrichment programmes for children, adults and the elderly in Manhattan and the Bronx.

Claudia Lewis