Resilience and diversification drive demand for under-the-radar CLOS

Driven by an environment of elevated yields and ample carry opportunities, the bond bull market that began in late 2022 is set to extend.

- Edwin Wilches, PGIM

Yet, with credit spreads now tighter than historical norms, investors are increasingly turning to collateralised loan obligations (CLOs) - an asset class offering higher yields and attractive risk-adjusted returns, which is expanding beyond its institutional roots at an opportune time.

Put simply, CLOs are fixed income securities consisting of aggregated corporate loans. Each CLO diversifies across 250 to 450 senior secured loans from various corporate issuers, which are segmented into 'tranches' based on subordination and income priority. Catering to a range of investor appetites, AAA tranches sit at the top of the capital structure and are considered the most risk-remote, while lower-rated tranches offer higher yields but carry greater risk.

A common misconception among investors is confusing CLOs with CDOs, the highly complex instruments made infamous during the 2008 global financial crisis. A key differentiator is collateral. CLOs are backed by diversified, transparent corporate credit, often from large, well-known companies. This robust collateral base offers greater protection and comfort versus legacy securitisations such as subprime mortgages.