Public Fixed Income

What is a CLO?

January 2023 – 4 min read

CLOs provide an efficient, scalable way of investing in floating-rate loans while offering structural protection that has historically performed well through multiple credit cycles.

A collateralized loan obligation (CLO) is an actively managed securitized product backed by a highly diversified pool of leveraged loans. CLOs provide an efficient, scalable way of investing in floating-rate loans while offering structural protection that has historically performed well through multiple credit cycles.

To simplify, think of a CLO as a company that raises money from debt and equity investors to purchase a pool of 150-200 diversified senior secured first-lien corporate loans, “the assets.” These assets are also called leveraged loans and come from large well-known borrowers, such as United Airlines, Virgin Media and Burger King, that have below investment grade ratings and high levels of debt. The loans are floating rate and pay interest on a monthly or quarterly basis with a spread above an index (typically SOFR or LIBOR). Additionally, the senior secured nature of these loans has resulted in historically higher recovery rates compared to senior unsecured bonds.

Juxtaposed with the assets are the debt obligations, or “the liabilities,” which are sliced into “tranches” that re-distribute the risk of direct exposure to the portfolio of loans by offering tiered credit enhancement and structural protections. A typical CLO structure combines five or more classes, from the senior most tranche rated AAA down to the most junior and highest-yielding debt tranche rated BB-. The tranches are floating rate like the assets and are due a coupon on a quarterly basis.

After paying off expenses and liabilities, a residual unrated “CLO Equity” tranche captures the excess spread (returns) that the assets generate. As the equity tranche is leveraged exposure to the underlying leveraged loans, it is the riskiest piece of the CLO structure; however, it can also be the most lucrative.

23-2692512

Want to read the full article?

View PDF

Bo Trant

Client Portfolio Manager, Structured Credit

Tim Wolak

Client Portfolio Manager, Structured Credit

The document is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and must not be treated as, investment advice, investment recommendations, or investment research.

In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved and before making any investment decision, it is recommended that prospective investors seek independent investment, legal, tax, accounting or other professional advice as appropriate.

Unless otherwise mentioned, the views contained in this document are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Parts of this document may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any forecasts in this document are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Any investment results, portfolio compositions and/or examples set forth in this document are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this document. No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments.

Investment involves risks. Past performance is not a guide to future performance. Investors should not only base on this document alone to make investment decision.

This document is issued by Baring Asset Management (Asia) Limited. It has not been reviewed by the Securities and Futures Commission of Hong Kong.

Related Viewpoints