The Case for Collateralized Loan Obligations (CLOs)
Key Takeaways „
- CLOs offer portfolios of floating-rate bank loans securitized across the rating spectrum. The availability of floating-rate bonds is limited in the U.S., and the choices for highquality floating-rate securities is even more limited, yet around 80% of CLOs carry a credit rating from A to AAA. „
- Relative to the investment-grade corporate credit market, CLOs have offered a consistent yield premium across the rating spectrum, in some cases as much as two times the yield offered over U.S. Treasuries. „
- In an environment where interest rates are low and the risk of higher Treasury yields has risen, allocations to AAA rated CLOs may help investors diversify a traditional fixed income portfolio, offering lower volatility, higher credit-quality and less sensitivity to any rise in interest rates.
CLOs are not a new asset class, but their availability to a wider range of fixed income investors is. CLOs have been a part of the vast securitized products market, which includes mortgage-backed securities (MBS) – the second-largest bond market in the world – for about 30 years. Like all securitized products, a CLO manager pools together different loans to create a portfolio in an attempt to produce a more diverse and more secure offering. MBS does this for home mortgages; CLOs do this for commercial bank loans.
A CLO is a portfolio of bank loans securitized into different instruments offering varying credit risk and thus varying credit ratings, although around 80% of CLOs carry a credit rating from A to AAA1.
Bank loans are issued to smaller companies that cannot typically access the bond markets. They carry credit ratings below investment grade, and are often used to refinance existing debt, finance acquisitions, or recapitalize the company. With over 70% of companies in America below investment grade, the market is large at over $1 trillion and includes many household names such as Chrysler, Dell and Avis2. In the last five years, the loan market has doubled, nearing the size of the U.S. high-yield bond market, which, at about $1.5 trillion in total assets, is considered one of the major fixed income asset classes3.