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Building Diversified Portfolios with CLOs
By: Himani Trivedi, Nuveen
Collateralized loan obligations (CLOs) offer investors a wide variety of risk-return profiles and can play a powerful role in a portfolio allocation. CLOs offer enhanced income, a lower default experience versus similarly rated corporate bonds and diversification benefits for core bond portfolios.
This is an excerpt from NCPERS Spring 2025 issue of PERSist.
What Are CLOs?
Collateralized loan obligations (CLOs) are diversified, actively managed portfolios of broadly syndicated senior loans issued by corporate borrowers. These are pools of loans that are securitized or repackaged into interest-bearing securities of varying degrees of risk and yield and sold to investors based on their portfolio objectives. These securities, also known as tranches, can trade actively in the secondary market.
The junior-most tranches, starting with equity, absorb any losses from the portfolio first and are in turn compensated with the highest levels of yield and return. CLOs are not impacted by mark-to-market movements in their underlying loan portfolios and are not subject to margin calls or forced selling. This allows CLO portfolios to be managed through price volatility and potentially create trading gains when loan prices are dislocated.
The CLO Market is a Material Drive of Corporate Financing
At nearly $1 trillion in size1, the CLO market is the largest investor in the broadly syndicated loan (BSL) market, which companies look to for financing, among other options, such as bonds and private credit. Having weathered various market cycles, CLOs continue to witness investor interest grow from a limited set of institutional investors to a broader audience that includes banks, insurance, pensions, family offices and wealth clients.
Enhanced Income
CLOs offer enhanced yields and return potential compared to similarly rated corporate bonds or loans, as well as other fixed income options.
Reduced Default Risk
Despite their higher yields, CLOs historically have endured far fewer defaults across the rating spectrum than corporate bonds or loans. Notably, next to zero AAA to A rated CLO tranches have defaulted in the roughly 30-year history of the market.
CLO Debt Is a Strong Fixed Income Diversifier
Allocating to CLOs may help to further diversify a traditional allocation to fixed income, given the low correlations to core bonds, including Treasuries, mortgages and investment grade corporates. CLOs are a floating-rate asset class and exhibit very little sensitivity to interest rate changes, which reduces both rate risk and correlations to other fixed income sectors.
Endnotes:
1. Data sources: BofA CLO Factbook 16 Oct 2024.
2. Data sources: Corporates: Annual issuer-weighted corporate default rates by letter rating from Moody's “Default Trends – Global: Annual default study: Corporate default rate to moderate in 2024 but remain near its long-term average”; CLOs: US CLOs trailing 12-month impairment rates by cohort rating from Moody's “Impairment and loss rates of global CLOs: 1993-2023.”
3. Data sources: Corporates: 10-year horizon average cumulative issuer-weighted global default rates by alphanumeric rating, 1998-2023 from Moody's “Default Trends – Global: Annual default study: Corporate default rate to moderate in 2024 but remain near its long-term average”; CLOs: US CLOs, 10-year horizon WR-unadjusted cumulative impairment rates by original rating, 1993-2023 from Moody's “Impairment and loss rates of global CLOs: 1993-2023.”
Bio: Himani Trivedi is head of structured credit at Nuveen. She is responsible for managing loans and investments in structured credit across Nuveen-managed CLOs and various fixed income strategies. Previously, Himani served as a co-head of investments and head of structured credit at Nuveen affiliate Symphony Asset Management. She started at Nuveen under Symphony affiliate in 2004 on the convertibles desk, launched the CLO platform in 2005 and became co-Portfolio Manager for all CLOs in 2008. Prior to joining Nuveen, Himani worked on model validation for securitized products at Washington Mutual Bank and started her career in finance at ICICI Bank in India. Himani graduated with a B.S. in Chemical Engineering and an M.B.A. in Finance from Gujarat University, India and a Masters in Financial Engineering (MFE) from the Haas School of Business at University of California, Berkeley.
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