For the past few years, the primary strategy was originating and packaging loans. Now, with market volatility and sector-specific stress, the better opportunities are in buying specific, mispriced tranches of existing securities on the secondary market rather than originating new ones.
Rising delinquencies in subprime auto are not a sign of a uniformly weak consumer. The underperformance is largely confined to loans originated from 2022-2024, which were impacted by a unique combination of inflated used car prices and sharply higher interest rates, leading to strategic defaults.
Uncertainty around AI's impact on software companies is creating two distinct CLO markets. Older deals with high software exposure are heavily discounted and risky, while newly issued, software-light CLOs offer superior risk-adjusted returns, even if they aren't trading at a discount.
Unlike corporate bonds with distant bullet maturities, most structured credit products return principal monthly. This constant amortization shortens the asset's duration over time, making its value progressively less sensitive to interest rate swings and mark-to-market fluctuations during periods of distress.
This credit cycle could harm CLOs more than the 2008 crisis. The danger isn't a massive spike in defaults, but rather a prolonged period of moderate defaults combined with historically low recovery rates on those loans. This combination erodes value more effectively than a short, sharp shock.
While data centers are a hot commercial real estate (CRE) sector, the property-level investments offer narrow spreads unsuitable for hedge funds. A more compelling relative value play is in the high-yield corporate credit of companies providing essential technology and services to these data centers.
Regulations like Dodd-Frank shifted banks from being principal risk-takers to merely financing risk. During market dislocations, banks can no longer absorb selling pressure as they once did. This structural change creates a durable and profitable role for hedge funds to provide liquidity to distressed sellers.
While the non-qualified mortgage market is growing fast, re-performing loans (older, modified mortgages) are more attractive due to lower loan-to-value ratios (50-60% vs. 75-80% for non-qualified). This significant home equity provides a superior cushion against a potential housing price correction.