The Capital Markets

CHAPTER 23Collateralized Loan Obligations (CLOs)Demystifying a Versatile Asset Class

Mendel Starkman

WHAT IS A COLLATERALIZED LOAN OBLIGATION (CLO)?

CLOs are a type of investment fund. Similar to a mutual fund, a CLO is a professionally managed fund that invests in a pool of financial assets, specifically corporate loans. Unlike a mutual fund, however, a CLO is a structured fund. Instead of each investor owning a share with the same risk and return as all other investors, the CLO offers various investment tiers, each with a different risk‐and‐return profile. This chapter discusses the characteristics of a CLO, including its structure, underlying loan pool, and collateral manager.

At its core, the fundamental purpose of a CLO is to provide an efficient source of financing to below‐investment‐grade corporate borrowers. Corporations require funding for various purposes, including general business and growth opportunities, capital planning, or to finance acquisition activity. CLOs provide a meaningful source of funds from which these companies can borrow.

On the other side of the equation are institutional investors, who find that CLO tranches provide an attractive return for their level of risk. Investors may not be willing or able to lend directly to speculative‐grade companies. Instead, a CLO provides investors with a professionally managed, well‐diversified pool of such loans, with the added protection of loss shock absorbers that are inherent to the CLO structure.

The CLO ...