So far, Q4 has been quite the roller coaster for risk assets. Markets entered the last quarter of the year facing multiple headwinds; surging energy prices, supply chain disruption, the unwinding of fiscal support programmes, rising inflation and Covid cases, to name just a few.
Thankfully, the European ABS and CLO markets are usually less correlated to macro volatility and if they react, they do so with a delay. October has traditionally been one of the busiest months for issuance in both markets. Issuance this month kept pace with preceding years, with €6.4bn of European ABS and €2.2bn European CLOs issued during the first two weeks of Q4, making total year-to-date issuance €62.5bn and €28bn respectively. These figures reflect a 30% and 75% increase compared to 2020, leaving 2021 a post-GFC record year for issuance volumes. In addition, the CLO market has experienced €52bn of Refinancing volume over the same period (representing ~40% of the whole CLO market as of Jan 2021), with sponsors taking advantage of the strong demand for the product and better arbitrage.
The heavy supply and broader volatility have affected secondary market activity, with investors rotating into new issue papers and raising liquidity for future opportunities. The first half of the month saw around €1.1bn of paper in the secondary market, more than double the weekly average figure with good representation across different ratings and jurisdictions. Likewise, ABS markets have experienced some weakness in valuations, although limited to a couple of basis points at AAA level and 10-25 bps lower in the capital structure. However, despite that, the floating-rate nature of ABS and the boost to income from a potential rate hike preserved (if not increased) investor interest in the asset class. Oversubscribed primary ABS markets reflected this interest, with all tranches experiencing consistently high demand.
Meanwhile, CLOs once again noticeably outperformed other parts of the market. Accordingly, secondary execution remained solid with spreads stable across the capital structure and some tightening observed by participants for shorter and convex profiles due to the pricing in of additional refinancing activity . Meanwhile, in primary, investment-grade issues attracted new investors. AAA coupons have ranged between 0.97% and 1.02%, narrowing from the wides of 1.08% witnessed this summer, benefitting from the return of large anchor investors from the US and Asia persuaded by the asset class’ lack of duration and in search of floating-rate assets.
Meanwhile, mixed pricing characterised sub-investment grade, with tiering more pronounced due to deal and manager quality. Arguably, spread widening has been somewhat limited, ranging between 10-40bps versus September levels. With 8-10 new issues currently on the market, investors have the privilege to pick the best performing managers and discriminate on quality and price. Overall the broader volatility witnessed in other markets doesn't seem to have materially affected CLO primary and secondary levels so far. In addition, although spreads have widened a little bit, the higher income and capital gains from calls have made CLOs one of the best performing asset classes in the whole of fixed income.
The attractive spread level offered by CLOs relative to corporates and the strong performance of the leveraged loan market year-to-date explains the market's continued resilience. According to Morgan Stanley, the European high-yield index dropped by 1.1% over the past month, erasing most of the asset class' summer gains. In contrast, the total return on leveraged loans has remained in positive territory diverging from their cousins. If this divergence is partly attributed to the floating rate nature and the rate floors embedded in the loan market, supply and demand technical factors played an important role and will continue to do so. While both leveraged loan and high-yield new issue volumes are on track to reach a record year, the past month experienced outflows in high-yield funds and inflows in leveraged loan funds. In addition, the CLO primary market experienced one of the busiest years since the GFC and has absorbed most of the loan supply by growing over 21% in the past year. With numerous CLO warehouses open in Europe at the moment, the solid technical backdrop of the leveraged loan market is likely to continue and contribute to the asset class' resilience.
Q4 has just started, but for now, we welcome the strength of our market and the relative value opportunities that it offers. We would argue that European CLO debt at a yield range of ~1% of AAA to over 9% for single Bs still provides some of the best value out there.