European CLO issuance is expected, it says, to double to €75 billion ($86.4 billion) annually by 2030. CLOs are, according to one internet definition, a "form of securitisation where payments from multiple middle sized and large business loans are pooled together.” Such investments offer an opportunity for investors to gain exposure to higher-than-average returns by assuming default risk. Each tranche within a CLO has distinct risk-reward characteristics, with equity tranches offering higher potential returns at higher risk levels. We have carried commentaries about the CLO sector before. 

At a time when interest rates have fallen and there is a focus on sources of yield – of a risk-controlled nature – firms such as PGIM are saying that the asset class deserves attention. WealthBriefing recently spoke to Edwin Wilches, co-head of securitised products at PGIM’s fixed income business, about the sector.

WB: Why in your view are European investors keen on CLOs and what is driving this? 
Wilches: The bond bull market that began in late 2022 is continuing, driven by an environment of elevated yields and ample carry opportunities. Securitised products, particularly senior CLO tranches, stand out in today’s fixed income landscape for their strong relative value and attractive risk-adjusted returns. With credit spreads for most high-quality fixed income assets tighter than historical averages, CLO senior tranches offer compelling opportunities, especially at the top of the capital structure. Indeed, AAA CLOs continue to offer some of the widest spreads among investment-grade assets, with far less duration risk.

WB: I understand that CLO issuance is expected to double to €75 billion annually by 2030? Who is making this prediction?
Wilches: Most market watchers agree that CLOs will continue to serve as a key source of funding for corporate debt issuance in both the US and European markets, while also offering an attractive value proposition for debt investors. The issuance projections vary depending on the source, but €75 billion in euro CLO issuance is definitely within the realm of possibility by 2030.

WB: In your view, why has this market boomed in the US in recent years? What sort of investors are keen on it?
Wilches: In the years following the global financial crisis, a common misconception among investors was confusing CLOs with CDOs [collateralised debt obligations), the highly complex instruments made infamous during the 2008 global financial crisis. As time has passed and CLOs have demonstrated their resilience across multiple market cycles, a growing number of investors have given the asset class a closer look. More recently, this greater receptivity has coincided with a period of tightening credit spreads in more traditional investment grade assets, as well as the rise in rates that served as a return headwind for fixed rate bonds in 2022. 

While investors such as pension funds, insurance companies, and family offices have historically been active investors in CLOs, these market developments have led to greater uptake among investors in the wealth and private banking space.

WB: In terms that a lay investor can understand, how do CLOs work?
Wilches: Put simply, CLOs are fixed income securities consisting of aggregated corporate loans. Each CLO diversifies across 150 to 250 senior secured loans from corporate borrowers, which are segmented into ‘tranches’ based on subordination and income priority. Catering to a range of investor appetites, AAA tranches sit at the top of the capital structure and are considered the most risk-remote, while lower-rated tranches offer higher yields but carry greater risk. 

WB: CLOs today are backed by broadly syndicated, more transparent, senior secured corporate loans. What else can be said to reassure people who think that complex packages of loans or bonds make them queasy?
Wilches: A key factor differentiating CLOs from the pre-GFC CDOs is collateral. CLOs are backed by diversified, transparent corporate credit, from large, often well-known companies. This robust collateral base offers greater protection and comfort versus legacy securitisations such as subprime mortgages.

WB: Can you give examples of how they are less correlated to other markets? What sort of data is there on this? 
Wilches: Given their underlying corporate exposure, CLO tranches tend to be positively correlated with floating rate or shorter duration corporate of similar quality. Given the broad, liquid nature of the CLO market, there is ample data to demonstrate this (see below chart, “Correlations vs AAA CLOs”). While the correlation between CLO tranches and corporate debt is positive, it’s not one-to-one – and during certain periods, such as the UK gilt crisis, CLO tranches have exhibited lower downside volatility than corporate debt of similar quality (see “Historic 12-month drawdown” chart below), highlighting the diversification benefits this asset class can bring.
 
These benefits are even more pronounced when drawing a comparison with broader bond indices and developed market government debt, which have historically demonstrated low or negative correlation to CLOs.     

WB: In holding funds linked to CLOs, what typically are the fees/expense ratios?
Wilches: Fees and expenses can vary based on a broad range of factors including CLO tranche focus (e.g. AAA vs lower rated tranches), flexibility level (e.g. US-only vs full global approach), distribution channel, vehicle type, etc, so it really depends. 

WB: In terms of time horizons for investors, are these short/medium/long-term investment propositions?
Wilches: We see CLOs as offering a compelling long-term investment proposition. While some investors may take a more tactical, short-term approach, AAA CLO tranches can serve as attractive long-term allocations alongside other high quality fixed income exposures.

WB: Can you give me a general quote on why this asset class deserves more attention in Europe?
Wilches: The global CLO market is a large, established segment of the fixed income category. With momentum building since the late 1990s, these instruments are becoming a core component of broader fixed-income strategies. New structures are now democratising access for retail investors following decades in which CLOs comprised an exclusively institutional asset class. The US remains the largest market, but Europe is expanding rapidly.

For investors seeking to enhance yield with minimal credit risk, AAA CLOs offer a compelling alternative to traditional holdings such as government bonds and corporate debt. However, rather than simply replacing core bond allocations, AAA CLOs are gaining appeal as a complementary holding to improve a portfolio’s overall efficiency and diversification. For example, allocating 10 to 30 per cent of a traditional bond portfolio to AAA CLOs has historically improved risk-adjusted returns, especially during periods of market stress or rate uncertainty.