King Street Capital, a $19 billion hedge fund focused on the credit markets, is planning to launch its own collateralized loan obligation.
A CLO bundles up bank loans of differing credit quality and then sells tranches to investors like insurance companies. They’re closely related to collateralized debt obligations, or CDOs, which had a big part to play in the financial crisis.
King Street said now is an opportune time to launch a CLO given regulatory requirements, according to a client letter dated November 8 viewed by Business Insider.
New rules introduced following the financial crisis are set to force CLO managers to retain a certain portion of the CLO itself. The idea behind the so-called risk retention rule is to align the interests of the CLO manager with the CLO investors.
The rules are set to take effect December 24, and many have argued that they will negatively impact CLO formation. Issuance for this year through November 3 was 36% lower than the same period in 2015, according to a Reuters report.
That presents an opportunity, according to King Street. Here’s the relevant excerpt:
“While we have considered doing this in the past, we believe now is a particularly advantageous moment to do so. We expect the number of CLO managers to decline significantly as a result of the implementation of regulatory risk retention requirements. Managing our own CLO will create additional equity tranche investments for our funds. Additional benefits include the ability to control the selection of credits and avoid the payment of fees to third-party managers that can reduce CLO equity returns by 3-5% per year. It would also provide non-recourse leverage in a manner similar to our existing structured credit portfolio. Lastly, operating as a CLO manager would provide synergies to other parts of our portfolio, as it would complement our ongoing analysis of leveraged corporate issuers.”
The move to operate as a CLO manager is another example of the way in which alternative asset managers are moving further in to the lending business. While these funds have long bought and sold bonds and loans, now they are moving in to direct lending, financing everything from M&A deals to student loan refinancings.
King Street managed $19 billion as of mid-year, according to the Hedge Fund Intelligence Billion Dollar Club ranking. The fund returned 1.6% in the third quarter for a year-to-date performance of 3.02%, according to the letter.
ValueWalk earlier reported about the letter.