CLOs: Accessing high quality opportunities in structured credit

May 13, 2025

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Collateralised loan obligations can offer investors attractive yields, low duration risk and diversification.

Collateralised loan obligations (CLOs) have proved themselves over multiple market cycles, despite being unfairly painted with the same brush as the collateralised debt obligations (CDOs) that gained notoriety in 2008-2009.

CLOs, pools of first-lien corporate loans packaged into securitised structures, have little in common  with the high-risk, sub-prime mortgage-related CDOs of the early 2000s. Historically, the fundamental performance of CLOs has been strong and defaults negligible; no AAA-rated tranche has ever defaulted, and the cumulative default rate by number post the GFC is just 0.11%.¹ After a strong recovery in issuance in recent years, today the CLO market globally represents a US$1.4 trillion opportunity.²

For investors concerned with rising geopolitical and macroeconomic risks and falling government bond yields, a CLO allocation may offer access to diversification, potentially attractive yields and limited duration risk, with the ratings-based tranche structure catering for a variety of investor risk profiles.

How they work

A CLO comprises a pool of floating-rate loans (“bank” or “leveraged” loans) managed as a fund. Securitised loans are senior in the borrowing company’s capital structure and typically hold first-lien status, thereby reducing overall risk.

The CLO purchases the loans using debt and equity tranches, with the debt tranches rated from AAA to B based on their level of protection within the structure and payment priority. Typically, 90% of the structure’s securities comprising the senior and mezzanine rated debt tranches are floating-rate notes with a standard floating-rate note coupon structure. The remaining 10% are equity notes, which receive distributions after the servicing of the rated tranches.

Figure 1: Typical CLO Structure

Source: Muzinich & Co, for illustrative purposes only.

Today, there are over 200 CLO managers. While the majority (154) are in the US, Europe (66) is playing catch up; CLO management is an attractive asset management business, which firms look to roll out globally.³

A growing opportunity set

In the last 5 years, the asset class has become available to a broader range of investors. Exchange-traded funds (ETFs) have grown significantly in the US and have not been unduly impacted by recent volatility. In Europe, fund regulators have also begun to take a more open approach to the asset class, with  an increasing number of mutual fund and ETF structures. Growth has yet to take off to the same extent as in the US, but the pieces are falling into place, and we believe it is only a matter of time before the European market broadly mirrors its US counterpart.

CLOs themselves have also been subject to regulatory burden in the years post the GFC; while this has reduced in the US, Europe can be more difficult to navigate for the uninitiated. A recent “clarification” by European regulators has caused discussion among market participants.⁴ However, we believe the market will adapt and continue to grow, building on the issuance records set in recent years.

The net effect of regulation globally has meant CLO managers have moved to secure equity capital for multiple transactions. This has led to issuance becoming more programmatic rather than opportunistic, which in turn has led to improved liquidity for investors and an improved all-round issuance environment.

Low defaults

While the prospect of US tariffs are increasing the likelihood of a recession and commensurate rise in defaults and downgrades, we believe the highest-rated tranches will continue to be well protected.

As mentioned, and Figure 2 highlights, CLO defaults historically have been exceptionally low,¹ particularly in the tranches originally rated investment grade. We believe this can continue given assessments of junior over-collateralisation cushions still demonstrate meaningful headroom in both markets.⁵ If recent Trump administration actions lead to recession, we can expect loan defaults to increase, but it would take a sustained wave of defaults in the underlying loan collateral to pressure CLO debt tranches. As a result, an allocation could be appropriate for those focused on capital preservation, particularly in the senior tranches of the capital structure.

Attractive return profile

We believe an allocation into a CLO or fund makes sense as part of a broader, diversified portfolio. Highly-rated CLOs can be an alternative to money market funds or government bonds, as the yields compare favourably with comparable government bond yields (Fig. 3).

Historically, highly rated CLO bonds have provided attractive returns with lower volatility compared to similarly rated corporate or government bonds (Fig. 4). The floating-rate nature of the asset class can provide attractive income while limiting interest rate duration risks. As CLOs issue different tranches to meet different investor risk profiles, which look attractive versus comparably rated credit, an allocation can also improve a portfolio’s overall rating profile without sacrificing yield.

Past performance is not a reliable indicator of current or future results.

Source: UBS, JP Morgan and ICE Index Platform, as of 31st  December 2024. updated annually. JP Morgan Collateralised Loan Obligation Index (CLOIE); JP Morgan European Collateralised Loan Obligation Index (€-CLOIE); ICE BofA US Corporate Index (C0A0); ICE BofA Euro Corporate Index (ER00); ICE BofA US Treasury Index (G0Q0); Indices selected are best available proxies for the respective sub-asset classes. For illustrative purposes only.

Source: UBS, JP Morgan and ICE Index Platform, as of 31st December 2024. Updated annually JP Morgan Collateralised Loan Obligation Index (CLOIE); JP Morgan European Collateralised Loan Obligation Index (€-CLOIE); ICE BofA US Corporate Index (C0A0); ICE BofA Euro Corporate Index (ER00); ICE BofA US Treasury Index (G0Q0); Indices selected are best available proxies for the respective sub-asset classes. For illustrative purposes only.

In our view, many investors should consider CLOs as part of their short-duration fixed income allocations.

Floating-rate protection

One key benefit of CLOs for investors is their floating-rate structure, which can provide a natural hedge against rising interest rates. Even in a falling rate environment, CLOs can look increasingly attractive versus risk free rates, and also have a built-in floor on their benchmark rates, ensuring base rates do not drop below zero. This helps cushion some of the downside risk.

Additionally, lower interest rates can benefit the underlying leveraged loans in a CLO portfolio by reducing borrower costs and lowering default risk, ultimately supporting a CLO’s credit quality.

Compelling relative value

While corporate spreads have widened out somewhat in the recent volatility, AAA rated CLO spreads still appear relatively cheap versus A-rated corporates (Figure 6).

Risk aware

Nevertheless, investors should also be mindful of risks as they vary depending on where they allocate in the capital structure. While AAA tranches have never experienced a default, there are still risks around relative value versus comparable instruments. However, in most market scenarios, we believe AAA tranches compare favourably, and price drawdowns are usually relatively moderate. 

As one would expect, credit sensitivity increases the further investors move down the capital structure. More junior debt tranches and equity notes can experience capital losses if there is a meaningful and sustained wave of defaults in the underlying loan portfolio. However, these scenarios are rare, and, as shown in Figure 2, default statistics show default risk in CLO debt tranches over the last 25 years have been considerably lower than in similarly-rated corporates.⁶ 

Having diversified underlying portfolios is a key factor. Western European and US syndicated loan markets are well diversified across industries.⁷ Reducing concentration risk and helping to ensure portfolios are resilient during periods of economic/sector weakness are beneficial, although investors need to be mindful of overlap in underlying portfolios. Structural protections (through tranche segmentation) and portfolio management actions by the CLO manager can also prove useful in mitigating risk.

A lasting opportunity

With falling interest rates, evolving regulations and growing investor demand, we believe the CLO market is poised for further expansion in the US and Europe. While risks remain—particularly in junior tranches—the asset class has demonstrated resilience across multiple market cycles.

CLOs have proven to be a durable and compelling investment opportunity over the long-term, offering relatively attractive risk-adjusted returns, low historical default rates, robust structural protection, floating-rate exposure and diversification.

References

1. Standard & Poor’s, as of 31st December 2024. Most recent data available used.
2. JP Morgan, as of 31st March 2025. Most recent data available.
3. Pitchbook LCD, as of April, 2025
4. Joint Committee of the European Supervisory Authorities, as of 31st March 2025. Joint committee report on the implementation and functioning of the Securitisation Regulation (Article 44), final report.
5. Bank of America Global Research European versus USD CLO data Handbook as of February 7, 2025.
6. Standard & Poor’s, as of 31st December 2024. Most recent data available used.
7. JP Morgan, as of 31st December 2024. Most recent data available.

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of May 2025 and may change without notice.

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Index descriptions

C0A0 - The ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

ER00 – The ICE BofA Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of EUR 250 million.

G0Q0 – The ICE BofA  US Treasury Index tracks the performance of US dollar denominated sovereign debt publicly issued by the US government in its domestic market. Qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule, a minimum amount outstanding of $1 billion and at least 18 months to final maturity at the time of issuance.

CLOIE  - The JP Morgan Collateralized Loan Obligation Index (CLOIE) is the first rules-based benchmark for broadly-syndicated, arbitrage USD denominated CLO debt. Launched in July 2014, the index offers extensive coverage, tracking approximately 98% of the $774 bn US CLO debt stock1 as of January 31st, 2023. Representing the entire debt capital structure, the index covers 1,700+ deals and 10,000+ tranches managed by 140+ CLO managers. The CLOIE has an estimated $80bn in assets tracked to the indices, including 5 actively managed ETFs. This notes explains the construction, evolution and maintenance methodology of the benchmark.

€-CLOIE  - The JP Morgan European Collateralized Loan Obligation Index (€-CLOIE) is the first benchmark for broadly-syndicated Euro-denominated CLO debt, offering daily independent metrics on performance and analytics back to December 2017. The product aims to provide transparency into a historically opaque segment of the market, representing approximately 84% of the growing €230bn European CLO debt market. The index offers tranche-level metrics for more than 500 deals from 3,400 tranches managed by nearly 70 CLO managers across the debt capital structure.

JP Morgan EUR AAA CLOIE Index - is a subset of the JP Morgan Collateralized Loan Obligation Index (CLOIE), but only includes AAA rated instruments.

LUACSTAT – The Bloomberg US Corporate Bond Index measures investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.

LECPSTAT – The Bloomberg Euro-Aggregate: Corporates Index is a benchmark that measures the corporate component of the Euro Aggregate Index. It includes investment grade, euro-denominated, fixed-rate securities.

Important information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you.   performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall.

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