Creditflux Newsletter

The idea that the biggest will survive and prosper has persuaded many firms in the CLO management business to become consolidators. But lately, competition to acquire deals and whole managers has pushed prices sky-high.

In credit, the arguments in favour of size are well rehearsed. Only big firms can afford the teams of research analysts needed to cover hundreds of different credits effectively, say those who favour scale. And they argue that credit is a business that requires large amounts of expensive technology and data.

If you want a demonstration of the benefits of scale, the obvious example is Pimco. The unloved offspring of an insurance company based in a boring suburb on the west coast, Pimco has become the Microsoft of the credit world. It doesn’t pretend to be exciting. It has a geeky and secretive culture. It doesn’t have fans so much as begrudgingly loyal followers. But it has huge amounts of money under management from investors who trust it to get most things right.

That gives it clout. When Pimco wants to trade, investment banks bow to its terms. When a bewildered government official somewhere wants to pay an outsider to value a portfolio, she knows her job will be safe if she hires Pimco.

The other obvious example is BlackRock, Pimco’s twin in the fixed income world. BlackRock has had to work harder to get to the same scale as Pimco, and it doesn’t display the same kind of effortless superiority. Call it the Hewlett-Packard of the credit world, if that is not stretching the tech analogy too far.

Like Pimco, BlackRock has demonstrated that it can use its bulk to its advantage, building what is probably the most lucrative advisory business in history, and attracting lots of assets under management despite its mistakes during the credit crisis. Its reward for its efforts to bulk up has been a surge in its market capitalisation over the past 10 years.

The problem with all this is that there is no credible evidence that big credit managers perform better than small managers. And there are plenty of reasons to think that they should not.

The equity market clearly believes that big is better. But the consensus in favour of size may be one of those pervasive delusions that occasionally grab the market, like the one that favoured industrial conglomerates in the 1980s.

The most obvious problem with being big is that it is hard to beat the market if you own it. Another problem is how to persuade gifted portfolio managers to work for a big company, with all the bureaucracy that inevitably brings.

Certainly, in the CLO business there is no clear relationship between size and performance. Some of the best performing managers are big. But many are not.

One CLO investor argues that the best CLO managers are firms where the portfolio managers own the company, and which have between two or six CLOs under management. The advantage of being this size is that these firms can generally get the allocations to loans and bonds that they want. A firm with 30 CLOs and a handful of mutual funds to feed needs to buy large amounts of every new deal. It will end up paying over the odds for low quality assets.

Lately, quite a lot of managers seem to be cooling on the idea of growing their CLO business through acquisition. They have seen the prices that public companies, such as Ares, Babson, GSO and Invesco, are prepared to pay, and they have learnt how much of a distraction a protracted bidding process can be.

As a result, they have decided, quite rightly, that consolidation is not for them.