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Tuesday, 29 January 2019

The collateralized loan obligation (CLO)

The collateralized loan obligation (CLO): The slightly better-behaved sibling of the collateralized debt obligation (CDO), the asset class that — lest we forget — came so close to ruining the Western financial system in 2007-08. As part of its deep-dive series into the leveraged loans market, the FT has the low-down on these debt instruments.

What are they? CLOs operate in much the same way as CDOs. Managers take a handful of loans at varying risk levels and package them into a CLO. Investors then buy the CLO and earn returns as and when loan repayments are made. Triple-A CLOs made up of safe loans are low-yield and pay out less, while CLOs containing high-risk debt carry higher yields.

So what’s the difference? CLOs are less likely to induce the apocalypse, CLO managers reassuringly tell us. Changes to the way that ratings agencies evaluate the underlying loans better reflect their performance and provide more protection to investors, the article says.

Why should you care? The market is growing rapidly, having doubled to more than USD 600bn between 2015 and 2018.

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