The size of the collateralized loan obligation market is revealing an interest pattern in alternative debt investment opportunities, particularly in Europe and the U.S., according to David Lindstone, executive director at Benefit Street Partners Alcentra, which is owned by Franklin Templeton Investments.
“It’s about US$1.4 trillion globally at this point, so it’s a very meaningful market.”
CLOs started as bank syndicated loans bundled for investors capable of carrying risk for potentially higher than average returns, he said, noting the asset is popular with investors looking for floating rates and risk flexibility.
The asset contains loans with traditional ratings indicating their status in the group and these loans provide interest in principal cash flows over time, said Lindstone. A CLO manager will collect between 150 loans and up to 300 loans at times in a special purpose vehicle, he added.
“The higher rated tranches obviously have more subordination and therefore better credit protection.”
The liquidity profile of CLOs can’t match the profile of corporate bonds, but in secondary markets the bundle investment method is “fairly liquid,” he said, which makes them available to be actively traded if needed.
Lindstone called portfolios in the European CLOs market slightly less diverse compared to the U.S., leading rating agencies to require increased par subordination. However, he added, the market still includes more than 100 issuers.
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“But from a mathematical standpoint, the ratings agencies do differentiate there. As a result of the BB tranche being a little bit less levered, European deals also generally issue a B tranche.”
It’s rare to see defaults in the loans depending on the rating attached, noted Lindstone. “There has never been a default at the AAA or AA level in Europe. There has been one default at the AA level in the U.S and that was actually driven by a court proceeding, not deterioration of the deal.”
He’s seeing comparable performance from the lowest rated tranche of CLOs against high yield bonds and high yield loans in the corporate space, with BB and B rated groups even outperforming sub-investment grade credit.
“You’re getting double digits to even low mid double digits from these. [The] bonds are de-risking themselves fairly quickly, which makes these particularly attractive as well.”
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