Your questions on Collateralized Loan Obligations (CLOs) answered

January 6, 20244 min read
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A Collateralized Loan Obligation (CLO) is a securitized portfolio of 100+ senior-secured corporate loans. Loans are pooled together by a CLO manager, securitized, and then syndicated to investors.  

Despite being a $1T+ market1, CLOs have only recently become broadly available through exchange-traded funds (ETFs) — and now on Yieldstreet. 

We recently hosted an investor webinar exploring how CLOs work, the market opportunity, and more. Read on for answers to our most-asked questions, or watch the full replay below. 

How does a CLO work?

  1. Asset managers purchase 100+ senior-secured floating rate loans to form a CLO, generally from major corporations.
  2. To fund the purchase of the underlying loans, the manager sells stakes in its CLO to debt and equity investors. The debt portion of the CLO is organized into multiple levels, known as tranches, that investors can select from. A final equity tranche sits at the bottom.
  3. As loans in the CLO distribute principal and interest, cash flows from the top tranche down on a quarterly basis. Not until all interest owed to the AAA tranche is paid does AA receive payments, and so on.

    Because AAA is the first to be paid, it is the lowest-risk tranche. As a result, it also will have the lowest target yield.

    As you move down the tranches, risk and return will increase.
  4. In addition to quarterly interest, CLOs can be sold, generating potential capital appreciation. 

This short video illustrates the above steps. 

What do the underlying loans in a CLO look like?

The underlying loans in a CLO can vary in terms of characteristics (e.g., maturity and credit quality), but they generally share certain common features. Typically, CLOs are composed of senior-secured leveraged loans issued by major corporations and, in some cases, may include loans issued by middle-market companies.

CLOs tend to have favorable risk-adjusted returns as they are inherently diversified across various companies operating in different geographic regions, industries, and sectors. 

It’s important to note that the specific characteristics of the underlying loans in a CLO can vary depending on the selection of the loan portfolio, structure, and purpose of the CLO, as well as market conditions. The investment manager’s expertise and ability to craft a quality loan portfolio are critical factors in determining the overall performance and risk of the CLO.

How is making a direct investment in CLOs different from a CLO ETF?

ETFs are index-based, meaning they invest in a wide range of CLOs with diverse characteristics encompassing the entire CLO spectrum. In contrast, Yieldstreet sees value in actively selecting the underlying risk tranches, CLO managers, and CUSIPs. For example, we see value in investing in BBB and BB tranches in the current market environment. This allows us to target specific opportunities where we see potential risk-adjusted solid returns. 

Yieldstreet focuses on being buyers and holders, predominantly making informed, long-term decisions regarding CLO holdings. This approach is designed to circumvent the susceptibility to the full extent of price volatility that ETFs may expose investors to.

What will happen to the performance of CLOs in a recessionary environment? 

Historically, the tranches of CLOs we favor for our portfolios have consistently exhibited minimal default rates. In the event of defaults within a particular tranche, Yieldstreet structures offerings with robust reserves, allowing investors to have added protection and better safeguard their principal against potential investment risks.

Who manages your CLO portfolios? 

In our extensive manager selection process, we sought a partner who we believe possesses deep experience in CLOs and other structured credit products. After careful consideration, we chose Prytania, a seasoned firm with 20+ years of experience and $2.2 billion in assets under management (as of September 2023). Prytania’s team offers global trading capabilities with offices in both New York and London. Additionally, their extensive experience in credit review helps ensure a thorough assessment of the underlying loans in the CLO.

Why should I invest in multiple CLO portfolios? 

Each CLO portfolio we offer consists of a unique pool of corporate and middle-market loans across regions, industries, and sectors. This means that you can potentially achieve an even higher level of diversification when you invest in multiple funds, helping to reduce risk. 

Additionally, each time we offer CLOs on our platform, the market backdrop is slightly different. This is similar to the concept of dollar-cost averaging, where you get different entry points to take advantage of rising and falling yields.

1 Source: JP Morgan, as of Nov 2022.

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