So if a CLO fund raises some money to go and buy loans, that loan flows through the capital structure and goes back into the pockets of investors.
Aside from the management fees, how else would a CLO fund make money in this structure? Do they get a percentage of the cash flows that are given to the investors in different tranches? And if so, do the performance fee percentages based on the tranche level change?
Would appreciate any insight!
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They get additional performance fees from meeting an IRR hurdle and they also hold some of the equity tranche.
An irr hurdle on what? Dont the investors have a say in what loans the fund buys based on their risk profile? Eg Less risky investors would be given triple a tranche. I might be a little confused on how this is set up pls correct me if im wrong!
Read up on how a CLO works, but I can provide some basic color. A CLO is a pool of loans managed by an asset manager (the "CLO fund" referenced). These loans pay interest, this interest goes down the capital structure based on what the bonds accrue (index + margin). The excess gets paid to the equity tranche, up to an IRR hurdle. Once the equity tranche reaches that hurdle, the is an additional incentive fee paid to asset manager on top of the base management fee.
In other words, the structure of a CLO is very much similar to the structure of any other investment vehicle, such as as hedge fund where the management fee is (in theory) 2 and 20, or private equity, where IRR hurdles are more common.
An IRR hurdle in equity returns I believe. And no, the investors have a choice, not a say. It’s up to the investor what tranche they want to invest in. So it’s up to you as the investor if you want to invest in the AAA rates tranche or the BB- tranche or anything in between.
https://www.guggenheiminvestments.com/perspectives/portfolio-strategy/c…
Here is a pretty good primer on A CLO to get a better understanding.
+1 thanks for the insight!
How do ratings work for CLOs? If company falls into junk by moody's or S&P, is that credit sold immediately or do CLO PMs have ability/desire to hold crap-rated credits for some time if they believe ratings will improve or price will recover?
I haven't been able to find this info online and believe it is manager-dependent but any help would be appreciated.
CLOs have covenants that will hamper, but not preclude, the ability to hold junk securities. I don't feel like typing a lot so I'll just include this excerpt from a CLO primer online.
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