Year: 2023

08 Dec 2023
Insights Shiloh Bates 0 comment

Podcast: Demystifying CLO Myths

Flat Rock Global CIO Shiloh Bates discusses CLOs (Collateralized Loan Obligations) with Macro Hive CEO Bilal Hafeez on the Hive Podcast. Learn more about characteristics of different CLO tranches, CLO issuance, and the self-healing mechanism, to name a few.

Listen Now

DISCLOSURES

The performance data quoted in the podcast represents past performance. Current performance may be lower or higher than the performance quoted in the podcast. lnvestment return and principal value will fluctuate, so that shares, when redeemed, may be worth more or less than their original cost. Past Performance is no guarantee of future results. A Fund’s performance, especially for very short periods of time, should not be the sole factor in making your investment decisions.

Consider the investment risks, charges, and expenses of the Fund carefully before investing. Other information about the Fund may be obtained at https://flatrockglobal.com/flat-rock-opportunity-fund/. Please read it carefully.

Risk: The Fund is suitable for investors who can bear the risks associated with the Fund’s limited liquidity and should be viewed as a long-term investment. Our shares have no history of public trading, nor is it intended that our shares will be listed on a national securities exchange at this time, if ever. No secondary market is expected to develop for our shares; liquidity for our shares will be provided only through quarterly repurchase offers for no less than 5% of and no more than 25% of our shares at net asset value, and there is no guarantee that an investor will be able to sell all the shares that the investor desires to sell in the repurchase offer. Due to these limited restrictions, an investor should consider an investment in the Fund to be of limited liquidity. Investing in our shares may be speculative and involves a high degree of risk, including the risks associated with leverage. Investing in the Fund involves risks, including the risk that shareholder may lose part of or all of their investment. We intend to invest primarily in the equity and, to a lesser extent, in the junior debt tranches of CLOs that own a pool of senior secured loans. Our investments in the equity and junior debt tranches of CLOs are exposed to leveraged credit risk. Investments in the lowest tranches bear the highest level of risk. We may pay distributions in significant part from sources that may not be available in the future and that are unrelated to our performance, such as a returns of capital or borrowing. The amount of distributions that we may pay, if any, is uncertain.

ALPS Control Number: FLT000395

17 Oct 2023
Educational Videos, Insights Shiloh Bates 0 comment

Video: Interval Fund Basics

What is an interval fund? How is an interval fund different from other investment vehicles? Flat Rock Global CIO Shiloh Bates explains interval funds and why he thinks interval funds are growing in popularity.

Hi. I’m Shiloh Bates and I’m the CIO of Flat Rock Global.

Today I want to talk to you guys about interval funds and why we think they’re growing in popularity.

To purchase an interval fund is the same, simple funding mechanism as a U.S. mutual fund. It’s point and click; there is no paperwork. Now there is a daily share price, or NAV, net asset value, and that’s calculated by a third party. That’s the price at which investors can purchase shares of the fund. Now if investors want to sell shares, there’s a process by which they can tender those shares to the fund. And the fund agrees to a repurchase of at least 5% of shares per quarter, or 20% per year.

Now, practically speaking, an investor who wants to tender shares should get back much more than the contractual minimum. That’s because it’s very unlikely that all investors would tender at the same time.

The interval fund structure enables the fund to invest in illiquid assets that have a return premium associated with them. The premium is then passed along to the fund’s investors as dividends over time.

Interval funds make less-liquid asset classes typically reserved for institutional investors available to retail investors without the accredited or qualified investor limitations.

There are four primary reasons we believe interval funds will increasingly take share from private funds or closed-end funds. First, when you decide to invest in an interval fund, you can do it on that business day. You fund it to a portfolio where there’s already assets earning you return. There’s no concept of capital calls. There’s no setting aside cash, waiting for the capital calls to come in. You’re just fully invested on day one. Second, interval funds are SEC-registered and governed by the 1940 Act. And there’s a lot of regulation that goes along with that. For example, you’ll get annual reports, prospectuses, portfolio holdings, and caps on fund leverage, to name a few. But basically it’s the same regulation as a U.S. mutual fund. Third, in the interval fund structure, there’s no concept of trading above or below NAV. And that’s important because, for example, many closed-end funds, including BDCs, perpetually trade below NAV. In closed-end structures, changes in the fund’s discount in premium only adds to the overall share volatility. In the interval fund structure, it’s just not a concept. Fourth, for financial reporting, an investor in an interval fund receives a 1099. There’s no K1. And that’s going to make financial reporting much simpler.

So those are a few of the reasons we’re excited about interval funds. If you have any questions, feel free to reach out.

13 Jul 2023
Insights Shiloh Bates 0 comment

Common Mistakes in CLO Equity and BB Note Investing

Collateralized Loan Obligation (CLO) Equity is the riskiest tranche of a CLO, but also has the highest return potential, while notes rated BB are usually the CLO’s junior-most debt tranche. Both securities have attractive fundamentals, but it’s important to realize that these securities have some distinct features from other asset classes. Several key differences revolve around market illiquidity, conflicts of interest, CLO structural features, and market size. Below are a few lessons learned from our time in these asset classes:

1. CLO Equity investing, in particular, is not a great investment for investors that do not already have deep relationships in the market.

Imagine a CLO arranger has a $50 million equity tranche to sell in a new CLO. Who gets the first look? Given the investment size, the arranger generally cannot show the deal to multiple potential investors at the same time. That’s because each investor may want a majority of the equity, and if they all want the deal, many will be disappointed. So, the arranger starts with one account, and if that account passes, he moves on to the second. The pecking order is established by who does the most business with the arranger, among other factors. People new to the CLO asset class are going to find themselves last in line and will only see CLO opportunities that multiple others have passed on.

Similarly, it’s important that an investor sees other relevant market trades before making an investment. If you see a one-off trade from a broker dealer, it may end up being a fine investment, but you need to make sure you paid a fair price that is in line with recent market transactions.

2. An investor in CLO Equity should approach the market with the broadest possible mandate.

Many investors who want exposure to CLOs invest with one CLO manager in a GP / LP fund format that will invest in the next several CLO Equity tranches managed by that same manager1. This is an easy but inefficient way to invest. The investible universe of CLO Equity tranches is over 1,600 deals. The options are as follows: 

Primary CLOs – the financial market in which investors purchase newly-issued CLO securities

Secondary CLOs – where investors can buy and sell previously issued CLOs from other investors

CLO Warehouses – short-term financing vehicles provided by an investment bank to CLO managers to accumulate a pool of leveraged loans that will eventually be securitized into a CLO 

Middle Market CLOs – CLOs  with underlying collateral consisting of middle market loans rather than broadly syndicated loans

An investor in a GP / LP manager fund will be targeting the smallest fraction of the investible market, and there will be high overlap of the leveraged loans in each of the CLOs. Slowly waiting for the GP / LP fund to call capital may also be undesirable.

3. A CLO manager may not make the best CLO Equity Investor.

Many CLO Equity investors are also CLO managers, and they effectively market their CLO management skills as being useful in picking CLO Equity investments. However, this can quickly result in some conflicts of interest. Is the CLO Equity investor really looking at the whole market for the best opportunities, or is he simply helping the home team by investing in his firm’s CLOs? Let’s say the CLO Manager has syndicated almost all the CLO Notes for a new deal, but a few unsold parts of the capital structure remain. Perhaps those unwanted securities will end up in the CLO Equity Fund?

4. CLO BB Notes are robust, even when the market value coverage (market value of leveraged loans and cash / CLO debt through the BB Note) is less than 100%.

When the leveraged loan market sells off, potential returns in BB Notes can be equity-like. On its face, it seems very risky to invest in a CLO BB Note when, if the CLO was hypothetically liquidated, the proceeds would not result in full repayment. But, very few CLO BBs have defaulted, and there are two ways that the market value coverage likely ends above 100%, which is a requirement to get a full repayment on the CLO BB Note. First, many of the CLO’s leveraged loans will repay at par, thus increasing the market value coverage over time, as the fair value of the leveraged loans typically are below par. Second, if the CLO’s leveraged loans materially underperform, the diversion of cash flow that would have otherwise gone to the equity will also benefit the market value coverage. Do not underestimate the value of this CLO structural protection for the BB Note. 

5. Allocation to Middle Market CLO Equity and BB Notes has the potential to reduce overall portfolio risk. 

Middle Market CLOs offer exposure to a unique set of levered loans that aren’t represented in other CLOs. Projected equity returns are comparable to CLOs backed by broadly syndicated loans, but middle market loans tend to retain their value better in down markets. Changes in fair value of Middle Market CLO Equity are primarily driven by the actual performance of the underlying levered loans as opposed to technical factors influencing the broadly syndicated leveraged loan market.

1) GP / LP refers to a private fund structure where the General Partner (GP) typically manages assets on behalf of Limited Partners (LPs) who have contributed investment capital. GP / LP funds are not regulated under the investment Company Act of 1940.

DISCLOSURES

Past performance is not indicative of future results.

This Insight article is not an invitation to make any investment or purchase shares in any fund and is intended for informational purposes only. Nothing contained herein constitutes investment, legal, tax or other advice, nor is it to be relied on in making an investment or other decision. Nothing herein should be construed as a solicitation, offer or recommendation to acquire or dispose of any investment, or to engage in any other transaction.