Pearl Diver Capital LLP, a London- based money manager, is raising its fourth fund to invest in collateralized loan obligations as deal volume grows in the U.S. and Europe.
PDC Opportunities IV will raise about $250 million before first closing by early May, Chandrajit Chakraborty, managing partner and co-founder of Pearl Diver, said in a telephone interview. The firm, which closed its third fund of similar size in August, plans to deliver annual returns of 20 percent with 15 percent cash payments every year from the latest pool.
Investors from Apollo Global Management LLC to Pramerica Investment Management are raising CLOs in Europe after Cairn Capital Ltd. issued a 300.5 million-euro ($386.1 million) fund, the region’s first since 2011. CLO formation in the U.S. more than quadrupled to $55.4 billion in 2012 and is expected by Wells Fargo & Co. to reach $80 billion as Citigroup Inc. forecasts 3 billion euros of the funds in Europe this year.
“Investors are increasingly recognizing the merit of investing in structured debt where you get much better return on a risk-reward basis compared to other fixed-income assets,” Chakraborty said. “The CLO market has definitely turned the corner from the dark days five years ago.”
Pearl Diver closed its first fund to buy CLOs at about $200 million on Sept. 15, 2008, the day Lehman Brothers Holdings Inc. filed for bankruptcy. PDC Opportunities I generated an annual return of about 90 percent, according to Chakraborty.
CLOs pool high-yield loans and slice them into debt securities of varying risk and return, typically from AAA ratings down to B. The lowest portion, known as the equity tranche, offers the highest potential returns and the greatest risk because investors are the first to see their interest payouts reduced when the loans backing the CLOs default.
“With the market rallying so much since the fourth quarter of 2012, we see better value in the equity and the papers rated BBB or lower,” said Chakraborty, who founded the firm with Indranil Basu in 2008.
Leveraged-loan prices in the U.S. rose yesterday to 98.33 cents on the dollar following two straight days of declines, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index. The measure climbed 2.24 cents during the first quarter and is trading at an almost six-year high.
Pearl Diver’s second fund raised $200 million in 2011 and recorded an annual return of about 35 percent. Chakraborty sees more attractive opportunities in the U.S. as pricing of recent new European CLOs are “too tight” and the U.S. provides brighter economic outlook in a broader, more liquid market.
London-based Cairn priced its CLO in February, paying 140 basis points more than the benchmark rate on the top rated portion, according to data compiled by Bloomberg. A basis point is 0.01 percentage point. Leon Black’s Apollo may sell the AAA rated notes of its European CLO at about 135 basis points more than the euro interbank offered rate, three people with knowledge of the matter said on March 27.
With Europe still on the path to resolve the credit crisis, CLO investors will prefer new deals which allow managers more flexibility to trade or exit the underlying collaterals, according to Chakraborty.
Asset managers should also refrain from putting too many high-yield bonds in the asset pool of a deal as it may lead to lower recovery rates and damage the return when default rates rise, said Chakraborty, who sees the ideal bond allocation for a European CLO at about 20 percent.
The average spread for AAA rated CLO notes in the U.S. has narrowed 10 basis points this year to 120 basis points, while BB ranked pieces declined by 50 basis points to 625, according to JPMorgan Chase & Co.
In Europe, the spread for top-rated CLO notes tightened by 20 basis points this year to 150 basis points while the BB rated portion tumbled 425 basis points to 975.
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