Considerations when investing in a CLO

CLOs are a reliable source of cash flows for institutions that need a set yield over a period of time. Research from KKR shows that the 7,000+ AAA-rated CLO debt tranches issued between 1993 and 2022 had zero defaults, and even the lowest-rated debt tranche had only a 1.8% default rate.³ Yet, while CLOs offer attractive features and seemingly low default rates, they are not without risks.

A CLO’s performance can be influenced by various factors, including:

Credit risk
Interest rate risk
Liquidity risk
Potential for collateral deterioration
Regulatory and legal risks

How firms can model CLOs

Pools of collateralized loan obligations bring massive amounts of data. CLO investors need to track ratings to accurately assess risk, receive data from managers and trustees, and reconcile cash flows with their administrators. CLO managers must track, reconcile, and manage to accurately compute the size of their investment, positions, waterfall calculations, and more. There are several key infrastructure components that investment firms need to model their CLOs:

A security master to model the CLO tranche and, if relevant, link each tranche to the CLO parent
Tools that enable the CLO manager to track and deliver daily updates to the tranche holder, who in turn needs tools to properly ingest this data
Easy access to administrators and service providers for data to run models, unify information with other datasets, and make decisions
A robust loan warehouse to store data on underlying loans
A unified, domain-aware system to receive data and notices from managers, trustees, and loan servicers for changes such as re-rating on tranches or underlying loans

Efficiently managing pooled assets, particularly loans, demands a keen eye for detail and technical expertise.

Sources:

1 Understanding Collateralized Loan Obligations, Guggenheim, December 7, 2023

2 Barclays raises 2024 US CLO issuance forecast to $135-145B, PitchBook, March 21, 2024

3 CLO Liabilities: Carry, Diversification and Mitigating Default Risk for Credit Portfolios, KKR, March 2024