Collateralized Loan Obligations: Market Overview and Analysis
As the low rate environment persists in most major economies, collateralized loan obligations (CLO) offer the potential for income enhancement without materially increasing credit risk.
CLO debt tranches exhibit low duration risk due to their floating-rate nature, thereby protecting from mark-to-market losses as the Federal Reserve continues to increase rates.
They have shown lower loss rates and more stable ratings than comparable securitized products and corporate bonds.
In fact, AAA- and AA-rated CLO tranches have never experienced a default or loss of principal, even during the depths of the financial crisis.
We believe these features make the asset class a natural fit for investors who are concerned about rising rates in the near term, but believe we are in the late stages of the credit cycle.
While most institutional investors have been quick to embrace private equity, few have considered CLO equity as a viable allocation in their alternative risk budget. We believe CLO equity is, at the very least, a strong complement to private equity in a broader portfolio and in some cases CLO equity may even be an attractive alternative.
While CLOs tend to be volatile, through-cycle performance has been robust, and we believe investors can benefit from a strategy that tactically allocates across the different CLO tranches.
Given the complexity of the asset class, investors in this type of investment strategy need the appropriate resources and expertise to evaluate:
3. Investment style of collateral manager
Accordingly, we believe investors are best served by seeking managers with the appropriate expertise and resources to properly evaluate CLO opportunities.
In this analysis, we take a closer look at the evolution of the market and the compelling reasons why we believe CLOs will become an increasingly important component of institutional investors’ asset allocation strategy.