In this episode of The Last Tranche, Matt Layton, partner and head of Europe at Pearl Diver Capital, discusses strategies for investing in CLO debt and equity amid the recent rally in liabilities.

Layton says that analysing a manager's past behaviour is a better predictor of CLO equity returns than how a manager is tiered by the debt markets. He adds that some of the tier one managers have shown that they can be prone to sell loans too quickly during recent periods of volatility, which has caused those firms to lose their arbitrage faster than other managers.

Layton goes on to draw parallels between today's CLO market and the vintage of deals priced in 2006 to 2007, where equity cashflows were paused during the financial crisis. When spread widening occurred on the asset side (due to amend and extend activity pushing back 2010 maturity dates) equity returns were outsized once the CLOs came back into compliance with their tests. Layton forecasts a similar market technical to play out in the next several years.

Layton also discusses the investment opportunity in the US versus Europe, and how he expects the deterioration in credit quality, owing to higher interest rates, playing out amid forecasts that the US is no longer headed into a recession.