Manager dispersion is expected to widen in the second half of the year, as ongoing volatility creates clear winners and losers in the global CLO market, according to multiple market sources.

“We expect manager performance to show increased dispersion, with a more pronounced difference between stronger and weaker performers as volatility remains a defining feature of the market,” said Eddie O’Neill, co-head of global leveraged credit at KKR.

In the year to date, CLO managers have had to contend with a range of geopolitical risks, as well as inflationary pressures, lower loan supply, and portfolio shocks such as the software sell-off which rattled the market in the first quarter of the year. Arbitrage has also remained under pressure as underlying loan spreads have tightened faster than liability spreads. This has led some managers to offer sweeteners such as a share of their management fees, in an effort to attract and retain investors.

Gabriele Gramazio, a managing director in KBRA’s structured credit ratings group, told Creditflux that the loan market remains bifurcated, with weaker credits trading at significant discounts to par, while higher-quality loans continue to trade above par, limiting managers’ flexibility in asset selection.

“I expect performance differentiation among managers to become more evident, particularly for transactions whose reinvestment periods have ended, and which have been amortising for some time,” Gramazio said. “Asset selection and portfolio management will continue to be key drivers of relative performance. Credit quality remains generally stable, with selective distressed situations.”

Manager dispersion has been a topic of conversation amongst industry insiders since the start of the year, when the software sell-off revealed the dangers of overconcentration in CLO portfolios. Some managers were found to have had as much as 15% of their portfolio in software loans, while others maintained a much lower exposure, and those who could not quickly sell out of their higher-risk positions paid the price.

“There’s dispersion between managers willing to take action versus those that are kind of wait and see,” said Ryan Olsen, portfolio manager, CLO tranche investing, Napier Park. “Fortunately for CLOs we see that in the data, so there are managers who were quicker to lower their software exposure or they went in with lower exposure from the jump. Those managers came out looking on a relative basis a lot better. And we’ve seen a couple of what would have been characterised as very high tier one managers who really dropped the ball with software and had high exposure.”

Olsen added that investors have noted both dispersion in portfolio quality as well as managers in the year so far.

“In the year to date, investors have become more selective, with a decided preference for platforms with strong track records, scale and a credit-first approach,” said Landis Wood, managing director, head of structured products at Golub Capital. “We’ve seen those trusted managers be rewarded with access to full duration deals at historically attractive spreads, while less proven managers generally have turned to more expensive or shorter duration deals.

In the second half of the year, Wood is expecting more of the same. Meanwhile, the unpredictable macroeconomic backdrop continues to cast a shadow across the CLO space, with most analysts predicting a rise in defaults and LME activity before the year’s end. This will further test managers’ ability to react swiftly to market movements and find value in an increasingly competitive space.

“Our view is that…CLO managers should expect to see ongoing higher defaults, a significant ongoing workload and ultimately more manager dispersion as investors go through restructurings and value post restructuring drives tail performance in CLOs,” said Gianluca Consoli, European leveraged finance portfolio manager at PGIM.