CLOs: should investors allocate to this private credit strategy? An allocator’s perspective
Over the past several years, CLOs (Collateralized Loan Obligations) have regained significant interest among institutional investors. Long reserved for banks, insurers and large professional investors, this asset class is now starting to appear in allocations designed for private clients.
At the same time, many questions remain. Are CLOs really as complex as they are often portrayed? Are they comparable to the debt products that contributed to the 2008 financial crisis? Why do sophisticated investors continue to allocate several hundred billion euros to this market while it remains relatively unfamiliar to the wider public?
These are legitimate questions. CLOs often suffer from a reputation that precedes their understanding. Yet behind their legal sophistication lies a relatively simple economic logic: financing companies while allocating risks differently between several categories of investors.
At Private Corner, our role is not to promote an investment simply because it is fashionable. Our job is to determine whether a strategy deserves a place within a private markets allocation and, when it addresses a specific objective, to select the most relevant partner to implement it.
Private Corner supports wealth management professionals in building private markets allocations tailored to their clients’ objectives.
The real question is not: “what is a CLO?”
Most content about CLOs starts by explaining how they work from a technical perspective. That step is obviously necessary, but it does not answer the question investors are really asking.
The real issue is different: why include a CLO strategy in a portfolio when bonds, private debt funds and traditional fixed-income funds already exist?
A CLO is not an asset class in itself. It is a vehicle that provides exposure to a broadly diversified portfolio of loans granted to companies.
These loans, known as leveraged loans, mainly finance companies backed by private equity funds as part of LBO transactions. Contrary to a common misconception, these are not loans granted to distressed companies. They are most often profitable businesses generating recurring cash flows, with secured loans that usually rank high in the repayment priority in the event of default.
The CLO comes into play only after these loans have been originated. Its role is to acquire several hundred of them in order to build a highly diversified portfolio.
Why do CLOs raise concerns?
CLOs often raise concerns mainly because they are wrongly associated with the CDOs that played a major role during the subprime crisis. This comparison is largely misleading.
The CDOs of 2008 were predominantly backed by residential mortgage loans, often of poor quality and with limited transparency. CLOs invest in a completely different asset class: corporate loans selected by specialised teams, actively monitored throughout their life and broadly diversified.
Systematically comparing CLOs with CDOs means confusing two vehicles that may share a similar legal architecture but rely on fundamentally different underlying assets.
Our specialists can help you understand private debt strategies and their role within a wealth allocation.
What really drives performance
The return potential of CLOs is often attributed to their structure. In reality, the structure does not create performance. It simply organises how cash flows and risks are allocated between investors.
The true source of value creation lies first and foremost in the quality of the loans selected. In other words, an excellent CLO built on a poor portfolio will remain a poor investment. Conversely, a high-quality management team able to select credits rigorously is the primary driver of performance.
This distinction is essential. It explains why, in this strategy perhaps even more than in many other private markets segments, manager selection is probably more important than the vehicle itself.
The real risks of a CLO strategy
Presenting only the advantages of CLOs would be misleading. Like any credit strategy, they involve several risks that must be understood.
The first is credit risk. If the underlying companies experience significant difficulties, losses are absorbed first by the most exposed investors.
The second relates to management quality. Two CLOs investing in the same universe can deliver very different outcomes depending on loan selection criteria, company monitoring and how the portfolio is managed during periods of stress.
The third risk lies in the complexity of the structure itself. Waterfall mechanisms, coverage tests and reinvestment clauses require genuine expertise.
Finally, liquidity remains more limited than in listed bond markets. These risks exist. They should neither be minimised nor exaggerated. They explain why this strategy is still mainly managed by highly specialised teams.
Why do institutional investors continue to invest in CLOs?
If CLOs were as dangerous as their reputation sometimes suggests, it would be difficult to explain why they occupy an important place in the allocations of many insurers, banks and institutional investors.
The answer lies in several characteristics. First, the underlying loans generally benefit from security and repayment priority, which strengthen their risk profile. Second, diversification is significant. A CLO portfolio may be exposed to several hundred companies across different sectors and geographies.
Finally, this asset class has gone through several major economic cycles, including the 2008 financial crisis, the Covid-19 pandemic and the rapid rise in interest rates. This does not mean that CLOs are risk-free. It simply means that they are now a recognised component of institutional credit markets.
The essential question: what is the role of a CLO strategy in an allocation?
This is probably the most important point. At Private Corner, we never build an allocation starting from products. We start from the investor’s objectives.
A CLO strategy can address several needs:
- seeking a potentially higher level of income than traditional bonds;
- accessing the leveraged loan market indirectly, which is difficult to access directly;
- diversifying performance drivers within a private markets allocation;
- gaining exposure to a highly diversified portfolio of corporate financings.
However, a CLO strategy is not designed to meet every wealth objective. It does not replace private equity, direct private debt or infrastructure. It is a specific income engine, whose relevance depends on the overall construction of the portfolio.
Why manager selection is decisive
This is probably where an allocator can add the greatest value. Private investors do not have the resources to analyse several hundred corporate loans, compare different CLO structures or assess the quality of specialised management teams.
Our role is precisely to carry out this selection work upstream. In the case of our periodic-coupon private debt strategy, we selected CVC Credit not simply because it is a recognised name, but because its expertise is built on more than twenty years of experience in leveraged credit and CLOs, across several market cycles.
The strategy is based on indirect exposure to approximately 25 to 30 CLOs representing nearly 700 companies across Europe and the United States. This diversification is complemented by a Flexible Credit strategy managed by General Atlantic, in order to broaden performance drivers.
Our analysis is therefore not about deciding whether CLOs are “good” or “bad”. It is about answering a much more concrete question: does this partner have the skills required to manage this strategy sustainably in investors’ interests?
Private Corner’s approach: start with the need, not the product
The most common mistake is to look for the product offering the highest return. Our approach is different. We start from an allocation need.
In the case of Private Corner Credit Yield, the objective is to offer a strategy focused on the regular distribution of an annual coupon, relying on recognised institutional expertise. CLOs are not the final purpose of the strategy; they are one of the performance drivers used to meet this objective, alongside a complementary Capital Solutions strategy.
In other words, we did not create a fund “to invest in CLOs”. We built a solution designed to meet an income objective, then selected the expertise we considered most relevant to address it.
Conclusion
CLOs remain sophisticated instruments. They are not suitable for every investor and should never be analysed solely through the lens of their return potential. However, their reputation is often disconnected from their economic reality.
The right question is not whether a CLO is complex. Many institutional strategies are. The right question is under what conditions this strategy can bring genuine added value within an allocation, and with which partner it is implemented.
This is precisely the allocation-driven approach that guides Private Corner’s selection process: start from the investor’s objectives, understand the performance drivers being sought, and then select the expertise capable of delivering them with discipline over the long term.
Further reading on private markets
To complement this analysis, you can explore our guide to private debt funds, our method for building a private markets allocation, our guide to investing in private equity, or the landing page dedicated to funds currently open for subscription at Private Corner.
For a broader view of portfolio construction, you can also read our guide to building a balanced private markets allocation, our analysis of senior debt, and our guide to mezzanine debt.
Speak with our teams to structure a multi-strategy portfolio tailored to each investor profile.
FAQ — Understanding CLOs
Are CLOs as risky as the 2008 subprime products?
No. While CLOs and subprime-related products both rely on securitisation, they finance very different underlying assets. The CDOs involved in the 2008 crisis were mainly backed by lower-quality residential mortgage loans. CLOs invest in diversified portfolios of corporate loans, actively managed by specialists. Their structure also includes several levels of protection between the different investment tranches. The two products are therefore neither built in the same way nor exposed to the same risks.
What is a CLO and how does it work?
A CLO (Collateralized Loan Obligation) is an investment vehicle that purchases several hundred loans granted to companies. To finance these purchases, it issues different debt tranches and an Equity or junior tranche, each with a specific risk and return profile. The interest paid by companies is used to remunerate investors according to a predefined order of priority. This structure makes it possible to allocate risk between different categories of investors.
Why can CLOs offer higher return potential?
The companies financed pay interest on the loans they have taken out. Once the debt tranches have been remunerated, the remaining cash flows accrue to investors in the Equity tranche. This tranche benefits from leverage, which can generate high returns, but it also absorbs the first losses if the portfolio experiences difficulties. As with any investment, a higher return potential comes with a higher level of risk.
What happens if companies fail to repay their loans?
The first losses are absorbed by the Equity tranche. Only if defaults become much more significant can the other tranches be affected, according to their order of priority. This organisation, known as a waterfall, is one of the main protection mechanisms for the most senior investors. In addition, the strong diversification of the portfolio generally limits the impact of a single company’s default.
Who actually invests in CLOs?
The main investors have historically been insurance companies, banks, pension funds, asset managers and family offices. In recent years, this asset class has gradually become accessible to certain private investors through specialised funds. Access is nevertheless most often provided through experienced managers capable of selecting and managing these complex strategies.
Regulatory warning
This document is provided for information purposes only and does not constitute an offer to subscribe, a personalised recommendation, or investment, legal or tax advice.
The information presented may change and may be modified at any time. Only the legal and regulatory documentation in force is binding.
Any investment in private debt funds or strategies exposed to CLOs involves, among other things, a risk of partial or total capital loss, credit risk, illiquidity risk, valuation risk and requires a long-term investment horizon. Past performance is not a reliable indicator of future performance and management objectives do not constitute a guarantee of return.
Any investment decision must be made after reviewing the relevant fund’s regulatory documentation and assessing its suitability in light of the investor’s situation, objectives, investment horizon and ability to bear the associated risks.
