The case for European Collateralised Loan Obligations (CLOs)
Allocating to European Collateralised Loan Obligations (CLOs) opens up access to diversification and high-quality defensive income. Here the European Securitised team take a deep dive into the workings of the sector and evaluate the opportunities.
6 minute read
Key takeaways:
- The higher yield and defensive income profile of floating rate investments such as CLOs has attracted asset allocators looking to improve portfolio diversification.
- Relative value favours AAA CLOs which can offer enhanced spread and yield compared to investment grade (IG) corporate credit. History shows that AAA CLOs also deliver better risk-adjusted returns over the long term and during volatile markets.
- The diversity within the market and European regulatory environment necessitate an active approach to investing in CLOs, which can fully evaluate the risk and return potential of each distinct deal and capture relative value to optimise returns.
Collateralised Loan Obligations (or CLOs) are managed portfolios of corporate loans – rated below investment grade – that have been securitised. AAA CLOs offer the opportunity to capture high credit quality, defensive income and improve portfolio diversification. We believe they offer a compelling alternative to investment grade corporate bonds in a diversified fixed income portfolio and as floating rate instruments offer an opportunity to enhance returns from cash balances in a risk-controlled way.
In this Case for European CLOs, we take a deep dive into the sector, look at what history tells us and consider how investors can access the asset class.
Related insights
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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Important information
Please read the following important information regarding funds related to this article.
- An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
- When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise (or are expected to rise). This risk is typically greater the longer the maturity of a bond investment.
- The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
- Some bonds (callable bonds) allow their issuers the right to repay capital early or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the Fund may be impacted.
- If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
- The Fund may use derivatives to help achieve its investment objective. This can result in leverage (higher levels of debt), which can magnify an investment outcome. Gains or losses to the Fund may therefore be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets.
- Some or all of the ongoing charges may be taken from capital, which may erode capital or reduce potential for capital growth.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
- In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
- The Fund invests in Asset-Backed Securities (ABS) and other forms of securitised investments, which may be subject to greater credit / default, liquidity, interest rate and prepayment and extension risks, compared to other investments such as government or corporate issued bonds and this may negatively impact the realised return on investment in the securities.
Specific risks
6 minute read
Key takeaways:
- The higher yield and defensive income profile of floating rate investments such as CLOs has attracted asset allocators looking to improve portfolio diversification.
- Relative value favours AAA CLOs which can offer enhanced spread and yield compared to investment grade (IG) corporate credit. History shows that AAA CLOs also deliver better risk-adjusted returns over the long term and during volatile markets.
- The diversity within the market and European regulatory environment necessitate an active approach to investing in CLOs, which can fully evaluate the risk and return potential of each distinct deal and capture relative value to optimise returns.