Highland Capital Management, which last week returned investments and closed its CLO Value Fund I, is preparing to kick off another similar fund, according to a source familiar with the matter.
Highland will launch the vehicle because a number of investors in the CLO Value Fund I wanted to remain invested in the CLO market. A launch date for the fund, which has not been named, hasn’t yet been determined.
The CLO Value Fund I, which launched in November of 2008, invested mainly in the debt and equity tranches of secondary CLOs. The massive drop in secondary prices in the fall of 2008, followed by 2009’s rally, helped provide the fund’s investors with a 138% return. Likewise, the new fund will seek out opportunities in secondary CLOs, but it could also invest in new vehicles as well, because unlike the past couple of years, market participants expect new CLO issuance in 2010.
This optimism stems largely from the recent jump in new deals on the leveraged loan primary market, which has approximately $16 billion worth of loans in the pipeline, according to Standard & Poor’s Leveraged Commentary and Data. This time last year there was only around $4.4 billion in the pipeline.
Dallas-based Highland decided to return investments and close the CLO Value Fund I because “we sat down with our investors and told them that it was prudent to realize the gains, to take some chips off the table and to best position them for the next significant opportunities in the market in 2010,” said Gibran Mahmud, the fund’s portfolio manager.
Highland, which also manages its own CLOs, isn’t the only investment manager in leveraged loan land to return investments recently. BlueMountain Capital Management last month reportedly returned $100 million from a loan fund that had gained 34% since its inception in March of 2009.
“BlueMountain launches and unwinds opportunity funds based on market conditions, seeking to find the right fit for a given set of circumstances,” said a BlueMountain spokesman. “Most investors did reinvest their capital into other BlueMountain credit funds.”
Highland and BlueMountain closed these funds because the opportunity to achieve the huge returns of 2009 on the secondary market isn’t there anymore, mainly because average secondary prices now hover around par. Markit’s LCDX index, one secondary market barometer, hit a low of 74 cents on the dollar in March of 2009. Ten months later, the index reached an all time high of 104.51.
This, however, doesn’t mean that there aren’t still opportunities to find credits with potentially attractive yields on the secondary loan market, as well as on the primary, Mahmud said. “We still see plenty of opportunity for investors in [the CLO market] over the next six to 18 months. We believe that in the next phase of the recovery, it will be critical for investors to have both the experience and expertise in understanding the structural nuances of CLOs as well as the underlying loan collateral.”
CLOs are attractive because credit conditions are improving, loan prices are increasing and there are more encouraging signs in the macroeconomic picture, says Dave Preston, a CLO analyst with Wells Fargo.
“We continue to favor double-A tranches over triple-A tranches for more risk-adverse investors. For investors comfortable with the risk in junior notes, we still recommend going low in the capital structure,” Preston said. “While prices may soften slightly, there are many buyers who will step in if prices dip.”
Mahmud said his firm has received a lot of interest in CLOs from pension funds. However, “I think [the CLO market] appeals more to a broader base,” he said. “We’ve seen interest from a variety of sources, pension plans probably being at top of list. Then there have been a couple of insurance companies, sovereign wealth funds and endowments as well.”
Highland manages approximately $25 billion in senior secured loans, high yield credits and structured products.