CLOs explained: what are they and why should you consider them?
5 min read 30 Apr 26
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What is a CLO?
First developed in the 1990s, collateralised loan obligations (CLO) have withstood the test of time, proving resilient through the Global Financial Crisis and Covid to become a well-established, significant component of global fixed income markets.
CLOs are essentially a bundle of leveraged loans, managed like a portfolio, that have been securitised to allow investors to tap into the underlying leveraged loans via a series of interest-paying bonds, with varying levels of risk and return.
How does it usually work?
At the beginning of the CLO lifecycle, the CLO sells debt and equity tranches to investors in order to raise money to buy a portfolio of loans. Each tranche typically carries different benefits and risks: senior tranches (AAA/AA/A) are front of the queue for distributions of interest and principal, and therefore carrying the lowest credit risk, while the mezzanine tranches offer higher spreads in return for the increased exposure to the performance of the underlying assets. The equity tranche receives residual cash flows after all debt obligations are met, making it the most volatile slice but also has the greatest potential return.
Following the capital raising stage, the manager of the CLO buys the loans from the leveraged loan market. The manager can buy and sell loans throughout the reinvestment period which typically lasts four to five years. This allows them to preserve the portfolio quality, manage risks and respond to market developments. This is the point where an effective active manager can really add value.
At the end of the reinvestment period, the CLO manager can no longer buy new loans and the portfolio winds down as loans repay over time. During the amortisation period, the cash flows from this are used to pay down senior tranches first.
Finally, the CLO reaches the call period where, once enough loans have paid back, the remaining portfolio is sold and the CLO is redeemed by equity holders and the CLO closes.
Why CLOs?
CLOs can combine the potential for attractive yields, diversification benefits and structural resilience.
For investors seeking additional income while trying to avoid taking on additional risk, CLOs could offer additional spreads to traditional corporate bonds, providing potentially attractive income opportunities. The additional spread is typically the result of a ‘complexity premium’, as well as lower liquidity and regulatory requirements.
However, CLOs actually can present an attractive risk profile. The overall global CLO default rate came in at 0.05% in 2024, staying below 0.10% for the sixth consecutive year.[1] They are backed by broad, actively managed pools of senior secured loans, providing exposure to diversified corporate credit rather than concentrated single name risk. Additionally, their floating rate nature reduces duration exposure, which is particularly beneficial in an inflationary environment.
And why now?
We are in a supportive environment for CLOs, with strong issuance and an uncertain interest rate environment. Primary European CLO issuance reached a record high in 2025, nearing €60 billion, with market activity boosted further by numerous resets and refinancings.
Furthermore, given the current uncertain environment, CLOs have a reputation as resilient, well-protected instruments, able to withstand periods of volatility in comparison to traditional fixed income asset classes. We believe CLOs will continue to be a significant and strategically important asset class for investors seeking diversified, income-generating credit exposure.
The views expressed in this webpage should not be taken as a recommendation, advice or forecast. The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Where mentioned, past performance is not a guide to future performance.
1 https://www.spglobal.com/ratings/en/regulatory/article/-/view/sourceId/13508716
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast, nor a recommendation to purchase or sell any particular security.