Key takeaways:
- Floating-rate CLOs can benefit when policy rates rise, offering a potential counterweight to duration-heavy fixed-income allocations during uncertain rate cycles.
- A strategic CLO allocation may improve portfolio yield and risk-adjusted outcomes, reducing reliance on investors correctly timing interest-rate and yield-curve shifts.
- Active management matters because CLO exposure varies by tranche, industry concentration and underlying loan quality, requiring careful security selection and risk assessment.
Definitions
Active investing: An investment management approach where a fund manager seeks to outperform a specific index or benchmark through research, analysis and investment selection.
Aggregate bond portfolio: A fixed-income portfolio designed to represent a broad bond market, typically combining government, corporate and securitised debt.
Capital stack: The hierarchy of securities used to finance an investment structure. Each level has a different priority for receiving payments and absorbing losses.
Capital structure: The combination of debt and equity used by a company to fund its operations and finance its assets.
Collateralised loan obligation (CLO): A securitised portfolio of corporate leveraged loans rated below investment grade. The underlying loan pool is divided into tranches with different levels of risk and payment priority.
Core Plus strategy: A fixed-income investment strategy that combines a core allocation to higher-quality bonds with additional investments that may offer higher returns but involve greater risk.
Credit rating: An independent assessment of a borrower’s creditworthiness by a recognised agency. Standardised ratings range from higher ratings, such as AAA, to lower ratings, such as B.
Credit risk: The risk that a borrower will fail to make a required interest payment or repay a loan.
Default: The failure of a borrower, such as a bond issuer, to pay interest or repay the original amount borrowed when due.
Distressed debt: A security issued by a company that is in default or considered to be at high risk of default.
Diversification: A way of spreading risk by investing across different assets or exposures that may behave differently under the same market conditions. Diversification does not assure a profit or eliminate the risk of loss.
Duration: A measure of how sensitive a bond or fixed-income portfolio is to changes in interest rates. Longer-duration investments are generally more sensitive to interest-rate movements.
Floating-rate security: A debt security whose interest payments adjust periodically in line with a reference interest rate.
Global Aggregate portfolio: A fixed-income portfolio designed to represent a broad global bond market, typically including government, corporate and securitised bonds from multiple countries.
Investment grade: A bond issued by a government or company considered to have a relatively low risk of default, as reflected in its credit rating.
Leveraged loan: Privately issued debt from a below-investment-grade company that is generally secured against company assets and ranks ahead of unsecured debt for repayment in the event of default.
Liquidity: A measure of how easily an asset can be bought or sold without causing a significant movement in its price.
Maturity: The date on which a bond’s principal and any final interest payment are paid to investors.
Policy rate: An interest rate set by a central bank to influence borrowing costs, inflation and economic activity.
Principal: The original amount loaned to a bond issuer, which must be repaid to the investor at maturity.
Risk-adjusted return: An investment’s return or potential return considered in relation to the amount of risk taken to achieve it.
Securitisation: The process of pooling assets, such as loans or mortgages, and repackaging them into interest-bearing securities that can be sold to investors.
Securitised product: An investment security created by pooling financial assets, such as loans or mortgages, and repackaging them into securities for sale to investors.
Sovereign bond: A bond issued by a government to raise money to repay debt or finance public spending.
Tranche: A layer within a securitisation that has a defined level of risk, payment priority and potential return.
Triple-A (AAA) CLO: The highest-rated tranche within a CLO structure. It generally has first claim on available cash flows and the greatest protection against losses, although repayment is not guaranteed.
Underlying loan quality: The creditworthiness and financial strength of the borrowers whose loans make up a portfolio or CLO.
Volatility: The rate and extent at which the price of a portfolio, security or index moves up and down. Higher volatility generally indicates greater investment risk.
Yield: The income generated by a security over a specified period, typically expressed as a percentage.
Yield curve: A graph showing the yields of comparable bonds across different maturities.
View transcript
Seth Meyer: Welcome to the Janus Henderson Summit in Rome. I’m pleased to be joined with John Kerschner Global Head of Securitized Products, fresh off the stage from presenting to our European clients here in Rome. Obviously, the topic de jour in regards to securitized market for us, especially Janus Henderson, has been CLOs. European investors have largely been purchasers of corporate debt and in some cases, sovereign debt.
But the interest in CLOs is really starting to pick up. So maybe take a couple of minutes and explain to us, just in simple language, why people would be thinking about CLOs in today’s market and why it makes sense.
John Kerschner: Well, I think the narrative going into this year, Seth, was pretty straightforward, that we’re going to have central banks around the world cutting rates, yield curve steepening that would help duration in portfolios. Usually duration comes from sovereign bonds, U.S. Treasuries and or corporate bonds. And now we sit here in September, and just the opposite has happened. Right. Central banks have been raising rates. Yield curves have flattened. And what people are seeing out of their core plus, Agg, global Agg portfolios is actually negative returns. And that’s somewhat concerning.
What we are telling investors is that we do have products out there that are floating rate, namely CLOs, that go up and down the capital stack from triple A all the way down to triple B that actually have a positive effect when central banks raise rates, because the base rate that the central banks are raising are what determine the overall yield of the CLO.
Meyer: And maybe talk a little bit about the diversification benefits, because at the start in January, when the world was convinced that every central bank was going down this path of cutting rates, and nine months later, we’re all now convinced we’re going the opposite direction – Right – The market could be just as feeble either way. So maybe talk about the permanency of a CLO allocation in a fixed income allocation. How you would think about that? As an investor.
Kerschner: It’s very difficult to time markets. Right. And I think it’s a little bit of a loser’s game. So we have shown through our proprietary research that adding even 10% of CLOs in the portfolio can not only help the overall yield of the portfolio, but reduce the risk. So that’s where the permanency comes from because you’re not trying to time the markets, you’re just trying to build the best risk-adjusted portfolio you can with the tools that you have.
Meyer: So maybe we’ll take a deeper dive into sort of the mechanics of the involvement of what everybody wants to talk about today. AI, software, kind of the impacts in the broadly syndicated loan market, if you will, in how that’s that sector is specifically is impacting CLOs if at all.
Kerschner: Yes. We’re getting this question a lot from investors. It’s obviously all over the press. But the bottom line, the way CLOs are created is you take a portfolio of 100 to 200 leveraged loans, and then you put them in a securitization with a rating. And then those cash flows are divided up into different layers of risk. So the diversification benefits through that portfolio loans are massive.
Plus the securitization basically tells portfolio, the CLO managers, that they can’t have more than 15% in any one industry. So the max they can have is 15% in software. In actuality, in Europe it’s more like 9 or 10%. And then when you kind of haircut that by the percent that are actually trading at distressed levels or trading or having near-term maturities, it’s about 1%.
So when you think about software in CLOs, yes, there could be some more defaults over the next couple of years. But when you talk about a AAA CLO, the amount of defaults, whether it ticks up 1 or 2%, doesn’t come close to impacting the AAA portion of the capital stack.
Meyer: Yeah. So very far very, very different in risks.
Kerschner: Exactly, Exactly.
Meyer: So let’s put our client hat on for a second. And let’s, let’s assume for a minute that I’m a European wealth manager or an institutional investor contemplating making an allocation to CLOs today. What’s the message you’d leave with me?
Kerschner: Well, first of all, you have to educate yourself, right. We get that this is a new product for a lot of investors. They haven’t invested in them in the past. But don’t be scared of the complexity issue because they’re actually not that complex. CLOs are like any other securitization, whether it’s credit card loans, mortgage loans, auto loans, it’s just the pool loans, with the framework put around it, and then different levels of risk that are tranched out.
And we at Janus Henderson have produced reams of white papers, we have podcasts, we have webinars. We have all sorts of materials to help educate you as the investor and any of your colleagues, we are happy to walk you through the process and get you comfortable with this product. We’ve done it time and time again, and we’re very convinced that we can get investors to the point where they feel comfortable investing in CLOs.
Meyer: Well, thanks so much for joining us today, John. We really do appreciate it. And thanks for watching from Rome.
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