LFI held an exclusive interview with $63bn Polen Capital‘s CLO co-lead, Jim Stehli, highlighting high-level trends in BSL CLOs, such as the growth of CLO ETFs, particularly for Triple As. Stelhi explained that Japanese institutions continue to show significant interest in the product and insurance companies are expected to increase their participation updated NAIC rules, especially in higher-rated tranches. Stehli noted that while Triple A tranches are seeing robust demand due to technicals such as negative net issuance, equity tranches remain challenging due to their higher risk. He added that investors have a wide array of different investment platforms to choose room, including ETFs, interval funds and private credit varying liquidity profiles, catering to diverse needs.
LFI: What’s new at the firm? What are your thoughts on high-level CLO trends?
Polen Capital: High-level CLO trends this year include the growth of ETFs, which has introduced a new investor base, particularly for Triple As. Historically, the institutional market has dominated the CLO space for over 20 years, and the acceptance of ETFs has added diversity to the CLO market’s investor base. Although ETFs still represent a small percentage of the total outstanding Triple A tranches, there’s potential for growth if they continue to be seen as a viable investment alternative.
LFI: What about the interest from international players like Japan? We’ve seen significant appetite from institutions there.
Polen Capital: These large international players, such as Japanese institutions, could indeed move the needle more significantly than ETFs. These institutions can write substantial checks, which implies a bigger budget and potentially more impact on the market. CLOs, being the largest non-residential securitized asset class, offer the scale and yield profile that attract these investors. The higher spread over other ABS classes coupled with their excellent default history has made CLOs a compelling investment opportunity for such investors.
LFI: Earlier this year, BofA mentioned that RMBS and agency MBS would compete for investor attention. How do you see CLOs in this context?
Polen Capital: I didn’t see that specific piece, but we believe that insurance companies, under updated NAIC rules, are likely to continue or even increase their participation in CLOs, particularly in the Triple A, Double A and Single A tranches. This year in particular, the technical demand for CLOs, driven by amortization and deal calls on older-vintage deals, supports the market, especially for Triple A tranches.
LFI: What are the hardest tranches to place in the market right now?
Polen Capital: Triple A tranches are probably the easiest to place due to their liquidity and broad investor base. Equity tranches, on the other hand, are more complex and as the first-loss provider in a CLO carry higher risk and yield, making them a heavier lift. Finding the right investors for equity tranches continues to be more of a process.
LFI: How has manager tiering evolved in the current market?
Polen Capital: In tight credit markets, manager tiering compresses, and it can widen when credit spreads increase. For higher-rated tranches, the liquidity profile of the manager name matters more than the underlying credit quality, while for lower-rated tranches, both liquidity and credit profile are important.
LFI: How does the scarcity of loan collateral impact the CLO market?
Polen Capital: The new-issue market has opened up post-Labor Day, allowing new issue CLO volumes to pick up. Secondary loan prices are high, so managers have focused more on the new issue market, requiring patience when ramping deals. The setup for ramping a deal changes with market conditions.
LFI: Is there a “Trump trade” in CLOs?
Polen Capital: The CLO market is more focused on the Fed’s actions and the pace at which it will move. We believe that the yield on Triple A CLO tranches remains attractive, and the market is watching the Fed’s decisions closely.
LFI: Is there strong demand for short-term Triple A CLO paper?
Polen Capital: Yes, there’s demand from asset managers with shorter duration needs. Separately, banks and insurance companies prefer longer-duration structures with longer non-calls, while money managers look for shorter-term trades.
LFI: Does your firm focus on secondary market trades?
Polen Capital: Secondary trades can be attractive for their convexity, but in today’s markets, secondary offers little to no convexity. From our perspective, it makes sense to refocus on opportunities in new issues or resets that might be more appealing.
LFI: Are captive equity funds a good story topic? Any insights on those vehicles?
Polen Capital: Captive equity funds make sense for CLO equity investments, offering diversification and durable income. They emerged due to risk retention rules and remain a significant part of the market. These funds typically attract alternative investors like pensions and family offices.
LFI: If equity isn’t done through captive funds, what are the alternatives?
Polen Capital: Some managers still syndicate equity through bilateral partnerships or fully syndicated processes. This market still exists and offers investors various ways to participate.
LFI: Any thoughts on the different platforms for CLOs, like ETFs, interval funds, and private credit?
Polen Capital: CLOs offer higher yields than other credit products but with less liquidity. The choice of platform should match the investor’s liquidity profile. ETFs and interval funds offer more liquidity, while captive equity funds provide diversification and durable income but with less liquidity.
LFI: Any final thoughts?
Polen Capital: The volume of CLO issuance this year has been impressive, and the emergence of private credit CLOs has further complemented the market. Different platforms offer various options for investors to connect with managers.
David Graubard
david.graubard@levfininsights.com
+1 646 361 6095
