Collateralized Loan Obligations: Market Overview and Analysis

Executive Summary

  • 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:
    • 1. Collateral
    • 2. Structure
    • 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.