Barron’s | CLOs are One Fund Manager’s Best Idea for 2017

By December 16, 2016July 24th, 2017In The News

Mark Okada, co-founder and chief investment officer at Highland Capital Management, has a surprising choice for his best investment idea of 2017: CLOs, or collateralized loan obligations.

These are securities made up of packages of commercial loans issued usually by low-rated companies and sliced into different tranches. They are highly leveraged and have attractive, floating rate yields that vary depending on the credit risk and the tranche.

Currently, double-B rated tranches yield about 8%, down from even more in the third quarter as floating rate securities have gotten more popular.

But CLOS are still cheap, Okada argues, because of regulatory reforms that go into effect next week that require companies that manage these portfolios to retain part of the risk. Banking regulation has also lessened CLO demand.

Okada calls the regulation, “sand in the gears that has kept spreads in that business and in the CLO market, very wide.”

He doesn’t expect the Trump administration to get rid of the risk retention rule, but he does think that tweaks to banking regulations could allow smaller banks to buy more CLOs — which he says they would gladly do if they could because they are so cheap.

Okada elaborated at a conference this week:

I think CLO debt is probably one of my favorite ideas. And we really think you’re going to see insurance companies that are starving for yield, along with pension funds, sovereigns, and regional banks come into this market and compress those spreads. So I’m very bullish on that part of the market, especially since you don’t need to see the economy rebound for this to happen. It can happen even if the economy just flattens and waits for 2018 for fiscal policies to kick in. So it’s a good example of why we’re getting so much more constructive about what we’re doing and how we’re dealing with our feeling about the global outlook. A lot of areas we’re bullish on won’t see the impact until things actually get implements, but this is one of the few areas where you can capitalize on the prospect of pro-growth policies and deregulation immediately, even before all those things get completed.

Although CLOs are an institutional product, a lot of income-oriented mutual funds hold CLOs.

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