Until fairly recently, it has been difficult for private investors and their advisers to access opportunities in collateralized loan obligations (CLOs), but that situation is slowly changing. In particular, with the advent of high yield multi credit strategies, investors have a means of accessing the broader market opportunities within the high yield universe, including the potential benefits offered by CLOs.
Investors in today’s high yield market have a multitude of choices for how to access the attractive yields available, while tailoring the risk profile of their investment. Long gone are the days when U.S. high yield bonds were the only option for investors. Today, loans—or more accurately, senior secured bank loans—are a large and very important part of the high yield universe, offering credit investors a more secure way to earn potentially attractive returns by investing as a senior lender in businesses rated below investment grade. Additionally, investors can adjust their duration exposure and diversify globally.
While adding senior secured loans to a portfolio is one way for investors to diversify and customize their high yield allocation, there are additional ways to customize a portfolio’s risk and return profile by gaining loan exposure through collateralized loan obligations (CLOs). Slightly more than half1 of the loans issued in the high yield market are purchased by CLO managers and function as the collateral in newly issued CLO deals—but in investment terms, a CLO is more than just a ‘loan clone.’ CLOs allow investors to buy securities backed directly by professionally managed portfolios of senior secured loans.
The securities issued by each CLO include high quality (AAA, AA, A and BBB-rated) tranches that, due to their seniority in the capital structure, tend to be insulated significantly from potential losses, as well as more junior (BB, B-rated and equity) securities that provide a leveraged return typically yielding more than the underlying bank loans. The CLO market has helped to expand the global high yield market by providing customized risk and return profiles that appeal to a wide investor base.
1Source: J.P. Morgan, Credit Suisse Leveraged Loan Index. As of January 31, 2018.