Key takeaways:
- The higher yield and defensive income profile of floating rate investments such as CLOs has attracted asset allocators looking to improve portfolio diversification.
- Relative value favours AAA and BBB CLOs, which can offer enhanced spread and yield compared to investment grade (IG) and high yield (HY) corporate credit respectively. History shows that IG CLOs also deliver better returns over the long term versus other traditional fixed income.
- The diversity within the market and European regulatory environment necessitate an active approach to investing in CLOs, which can fully evaluate the risk and return potential of each distinct deal and capture relative value to optimise returns.
Collateralised Loan Obligations (or CLOs) are managed portfolios of corporate loans – rated below investment grade – that have been securitised. In our view, Investment Grade CLOs enable investors to capture attractive income without taking meaningful idiosyncratic risk. Moving into IG CLOs and earning an attractive credit spread can help sustain income levels should cash rates decline, while offering additional spread-based income if cash rates increase.
They also bring portfolio diversification benefits (Figure 4) due to their floating rate nature and diversification of loans within a CLO – which holds around 100-300 underlying loans – curated by a CLO manager.
With over 70 CLO managers in Europe and over 150 in the US across hundreds of deals, each one presents unique idiosyncratic risks and characteristics, driven by differences in collateral, management, and structure. This necessitates a focused approach to security selection, understanding each manager’s strategy and the specific risks of their CLOs.
In this Case for CLOs, we take a deep dive into the sector, look at what history tells us and consider how investors can access the asset class.
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