Sampension, the DKK325.6 billion ($47.5 billion) labour-market Danish pension fund has found a rich seam investing in AAA-rated Collatorised Loan Obligations (CLOs) where it earns a pick-up from traditional fixed income in loans with low default rates. These specialist vehicles invest in a pool of loans issued to companies and use them to back a series of bonds of varying degrees of safety. They are also the types of structures that rocked the financial system in 2008.
Anders Tauber Lassen, head of credit at the fund, won’t divulge the exact size of Sampension’s AAA allocation that sits alongside, rather than in, the pension fund’s €3.4 billion credit portfolio due its different risk profile. However, he explains that building out the CLO portfolio is done on an opportunistic basis, timed around the market when spreads are wide compared to other products.
“We think that AAA CLO paper is one of the most attractive, low risk assets out there at the moment and we feel quite comfortable taking this type of risk,” he says.
Rather than default risk, he says the real risk of CLOs is structural and related to complexity.
“It can be volatile from a market risk perspective but the likelihood of a default in a AAA CLO is very low.”
Moreover, he believes CLOs performance in the financial crisis and senior CLO paper traded at a discount, was more a consequence of the liquidity crunch due to the subprime crisis, than a malaise in the underlying deals. Visible in Sampension’s “high teen” CLO returns after the financial crisis, he says.
“In 2009, CLO’s were deemed among the worst products in the world, but our allocation had good returns over the cycle.”
He attributes much of the success to the structure of CLOs, arguing that although technically they are a securitisation, they are more an asset management product given the fact CLO specialist managers buy the loans off banks and parcel them into tranches for investors. In this way the loans behave like any ordinary fund, with the manager trying to make the portfolio perform.
“This is very different to a bank taking rubbish assets off its balance sheet, stuffing it into a vehicle and selling it off to unsuspecting investors,” he says. It makes Sampension’s CLOs allocation a hybrid mix of internal and external management with the bond-part of the allocation managed internally, but an asset manager behind the CLO tranches.
Half of Sampension’s €3.4 billion credit portfolio is investment-grade, although investments don’t have to be listed or publicly rated. The other half is in higher yielding and more risky structured credit, subordinated CLO tranches and emerging market debt – though here he notes that last year’s battering has left lukewarm enthusiasm for jumping into emerging markets if the fund can find value in developed markets.
This structure gives the whole portfolio a risk profile that sits between equity (with the more aggressive, high yield and emerging market allocation closer to private equity and alternatives) and non-credit fixed income.
“One part of the portfolio is more stable than the other; it is there for extra risk and extra return.”
It is this split that he believes gives the entire portfolio its edge.
“Many pension funds’ allocation to credit is a one-eyed giant, only there to take higher risk exposure. We think that it is a missed opportunity not to seek out lower risk opportunities.”
Investment grade opportunities
It’s this belief that is driving another strategy. Sampension is also tapping illiquid, investment grade private assets partnering with banks in club syndicates, asset managers and even doing some deals directly on its own balance sheet. The idea is that the illiquidity risk is balanced by the quality of the asset, he explains.
“When you go into something that is illiquid you sell your stop loss option, but that option has less value if it is investment grade, as the likelihood of something going wrong is a lot smaller. That makes it a good place to take illiquidity risk.”
Senior commercial real estate loans are one example. “This is getting less appealing because property is expensive, but there is good value in private financing products generally.”
Bank disintermediation due to capital rules is fuelling opportunities which particularly suit large investors like Sampension, he says. And although illiquid, investment in this space isn’t necessarily long duration with typical maturities of five years. “There are spreads above the EURIBOR curve north of 170 basis points for investment grade risk if you know where to look.”
In fact, working with banks on private co-investment facilities currently takes up most of Tauber Lassen’s time. With his banking background and experience working on the sell-side, it is an area in which he feels particularly comfortable.
“If you grow up on the buy-side you have a different skill set. Experience on the other side of the fence is important when you are investing with banks.”
Banks’ priorities include pension fund partners being able to provide drawdowns at short notice and being able to underwrite facilities without “dithering” or having inefficient approval processes, he says. Sampension has been investing in credit since 2000, and Tauber Lassen’s team of four portfolio managers are adapt at explaining any complexities to the board.
Sampension’s credit portfolio ensures diversity via a wide range of portfolio products. Rather than stock or name picking, the fund employs most of its strategies in a portfolio format that sweeps in instant diversity.
“On a look through basis we have more than 1500 credits referenced across our portfolio,” says Tauber Lassen. “Diversity is important because you are not paid for concentration risk in general. If you have concentration risk and illiquid assets, you’ve basically sold your stop loss option which is of greater value.”
Around 70 per cent of the credit portfolio is run inhouse and the fund uses 10 managers in all (although in the CLO allocation there are many more). Instead of co-investing in co-mingled funds Tauber Lassen favours managed accounts for the extra control and investment insight they bring. “This gives us overall control of what direction the portfolio is going in, and an ability to liquidate if need be.”
Fees depend on the product, but a typical fairly liquid, high yield investment “can go down to 20bps,” however he notes that from an economies of scale perspective this only works for some managers. In a closed-end fund he says costs can be as much as a 1.5 per cent fee plus a performance fee in a tally that impacts returns.
“With this kind of fee some of the risk premium that exists in direct lending disappears on the fund level. You have to ask yourself if as an investor on a net basis you really did get that extra risk premium for locking your money up for 10yrs or more.”
The current macro back drop is good for credit. It is easy for companies to borrow and the default cycle has yet to hit. When it does, he predicts it will be sector and company specific rather than broad based. But that doesn’t mean the sector doesn’t carry risks. Terms are becoming increasingly borrower friendly, and credit investors need to ensure they are legally protected. And peering further along the credit spectrum he observes more poorly run companies out there, only afloat because of abundant credit.
“These could be default candidates. They are relatively easy to identify,” he says. “There is lots of money being raised, waiting for distressed companies, but we don’t want to allocate there yet. We will wait until things get uglier before we put money into distressed funds.”
Moreover, today’s low interest rates make rotating out of traditional fixed income and stepping out on the risk spectrum more compelling. “I expect that our credit portfolio will grow but it does depend on the quality of investments available,” he concludes.