Hedge funds look at buying CLO managers as loans flounder

Par-Four Investment Management is a small New Jersey-based asset manager that is suddenly intriguing to some of the biggest investors in credit markets. It buys loans that get bundled into bonds, one of the hottest areas in debt markets this year, and a passel of money managers have looked into buying the firm in last four months, according to people familiar with the matter. The larger investors are betting the good times won’t last, and hope that owning a loan investment firm will allow them to profit when prices plunge.

Any firm that buys Par-Four would be following in the footsteps of famed hedge funds like Greg Lippmann’s LibreMax Capital and Paul Singer’s Elliott Management Corp, which have bought up or built loan investment firms this year. Managing loans that get packaged into bonds known as collateralised loan obligations (CLOs) can clue in an investor faster as to when particular borrowers are having trouble, or when prices in the market are low enough to make buying worthwhile.

“The CLO acquisition is going to make LibreMax smarter,” Lippmann said in an interview. “Now we have an in-house CLO team to bounce ideas off.” Their efforts recall Wall Street banks buying mortgage lenders and servicers last decade during the housing bubble, as they sought an edge in selling and trading mortgage bonds. While mortgage lending and servicing brought unwanted liabilities to banks during the crisis, the legal risk for CLO managers is viewed as minimal because the borrowers and investors are relatively sophisticated parties who would have more trouble claiming they were duped.

Buying or setting up a CLO manager can give a fund manager access to more information about individual companies, according to Floyd Tyler of investment manager Preserver Partners. A CLO holds 100-plus loans each selected by the deal’s manager. Any buyer of CLOs gets detailed reports on corporate borrowers, but CLO managers get additional information.

“If a firm plans to be active in distressed bank loans or CLOs during the next downturn, it can make sense to become a CLO issuer today,” Tyler said. By building infrastructure for a restructuring and investing platform now, an investor will be an “early mover,” Tyler said.

Lippmann famously helped Deutsche Bank bet against mortgages during the housing bubble, a move chronicled in the book and movie “The Big Short.” When the prices of mortgage bonds plunged during the financial crisis, he snatched up bargain securities, plowing around three quarters of his hedge fund into the debt. That timing helped the fund he co-founded in 2010 generate average annual returns of around 8.5%. Now Lippmann, along with a host of other money managers, are publicly expressing skepticism about corporate debt. Apollo Global Management cofounder Leon Black said this week that credit markets “have gone to bubble status.” Recent returns for most kinds of corporate debt reflect these doubts - Investment- grade company bonds for example have fallen around 3.4% this year, according to Bloomberg Barclays index data.

Leveraged loans have gained nearly 3% this year, making them one of the best performing US debt sectors, as Federal Reserve rate hikes have spurred investors to buy floating-rate assets like loans. But increasingly there are signs of weakness in the market. Since October, prices have been falling and more loan deals have been getting pulled. Investors over the last three weeks pulled money from leveraged loan funds at the fastest pace in four years, with $1.04bn of net outflows for the week ended December 5, according to Lipper. CLOs may be better equipped to withstand any meltdown in company debt than conventional corporate debt. Money managers that put CLOs together sometimes sell the obligations before they buy all of the assets backing the securities, meaning if the market tanks soon after they issue the CLO, they still have at least a few months to buy discounted assets. The instruments can also actively trade in and out of assets for about five years, giving them time to take advantage of any decline in loan prices.

And if the value of loans decline, deal managers often don’t have to sell, giving them more flexibility to navigate tempestuous markets. In the meantime, CLO managers earn stable fees from the securities they issue: about 0.4 percentage points per year on the outstanding debt.

That’s part of why Par-Four’s phone keeps ringing. The firm was founded in 2003 by Robert Burke, Lehman Brothers’s former global head of highyield, leveraged loans, and distressed sales, and manages around $1.7bn. A money manager could gain a foothold in the market by buying the firm, which also includes a hedge fund business. Par-Four is open to selling itself but may end up remaining independent. A representative for the firm declined to comment.

Elliott Management earlier this year hired Adrian Marshall to be chief investment officer at Elmwood Asset Management, a new CLO management group it’s setting up. Elmwood expects to hire more people as it staffs up. The riskiest portions of CLOs can return 20% a year, which helped propel record US sales this year, at more than $125bn. With sales that strong, some investors are cautioning about exuberance in the markets for both CLOs and loans. “Do I think there’s some frothiness? Absolutely,” Lippmann said. “A modest to moderate amount of stress in the corporate market won’t hurt CLOs, it might make them better. CLOs proved to be robust in the 2008 crisis. We think that could be the case again.”