Previously available only to professional investors, collateralized loan obligations (CLOs) are now open to mainstream investors who are seeking a greater variety of yield options. The market for CLOs has increased and become more liquid of late, and they do have appeal. The default risk of CLOs is very low, for instance — much better than some corporate high-yield bonds. But how do you buy collateralized loan obligations? Keep reading for that and more.
Collateralized Loan Obligations
These essentially are securities that are backed by a pool of corporate loans. Another way to say it is, CLOs are portfolios of mostly leveraged loans that are securitized and managed as funds. The aim of a CLO is to produce profits from payments on a series of leveraged loans.
Better Liquidity with CLOs
Insurers and banks once were the primary holders of highly rated CLO “tranches” – slices of a bundle of derivatives. Because such entities are typically long-term investors that don’t trade often, liquidity was markedly limited. In addition, CLOs were typically traded at significantly large sizes, usually between $1 million and $5 million.
According to Barron’s, liquidity has improved quite a bit since 2015, when the federal reserve began to raise interest rates. After so many years of rates that neared zero, assets such as leveraged loans and CLOs that have floating rates began to attract income-seeking investors. Loan issuance took off and CLOs took in a bunch of them.
Increased CLO Accessibility
Trading volume on the secondary market has risen substantially now that money managers have become CLO purchasers and peddlers. One result of this is the launch of retail-oriented goods such as exchange-traded funds. Such funds have helped make CLOs accessible to all investors
How CLOs Work
Debt payments derived from CLO’s underlying loans are put in a pool and distributed to investors of various CLO tranches. For example, there’s a AAA debt tranche, an AA debt trance, an A debt tranche, a BBB debt tranche, ultimately ending with the equity tranche, which provides the highest default rate and return – and the most risk. That’s just part of CLO characteristics. Investors can choose to put money in whichever tranche fits their profile.
How to Buy CLOs
As we’ve established, the CLO market has grown tremendously, which has rendered the asset class more liquid. In addition, there is now more protection for highly rated CLO tranches, and money manager participation has heightened trading volumes significantly. Consequently, the secondary market is quite busy, and the investor base is expanding.
However, there is no getting around that this is a leveraged loan market, although a prospectively less risky aspect of it. As we say, the CLO default risk is relatively low, but still worth mentioning.
Having said that, retail investors who are interested in CLOs should seek actively managed exchange-traded funds that invest exclusively in high-rated tranches. Doing so will provide loads of default protection while maintaining prospects for greater yields than you might have with investment-grade bonds.
In summary, if you are planning to buy collateralized loan obligations, that would make you part of a growing trend. The fact is that the size of the collateralized loan market has shot up from $400 billion in 2015 to more than $700 billion today. That’s quite a bit of growth.
However, CLOs are not the only alternative investments available – by far. In fact, platforms such as Yieldstreet are offering vetted opportunities other than stocks and bonds that traverse asset classes such as art and real estate, and which generate secondary income while diversifying investment portfolios.
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