VI. Collateralised Loan Obligations - A Hidden Treasure

As investors continue to expand their allocations to credit, the European market for collateralised loan obligations (CLOs) presents an increasingly interesting investment opportunity. Historically, concerns over complexity, structural leverage, and a misguided perception that CLOs are partly responsible for the last financial crisis have caused many investors to overlook this asset class. Depending on your perspective, CLOs are either overly complex financial instruments or, alternatively, products that provide investors with attractive risk-adjusted returns. At PDM, we stand firmly in the latter camp.

Many investors have historically shied away from CLOs, given the complexity of the asset class and lingering (unfounded) associations with the more obscure instruments which were one of the causes of the global financial crisis. Despite this, we at PDM have long believed that CLOs provide an attractive, risk-adjusted way for investors to invest in diversified corporate credit, and the PDM funds have been investing in the asset class for almost a decade across all tranches from AA to equity. For investors looking to take investment grade risk, CLOs offer returns of 3%+, while for sub-investment-grade risk, CLOs can generate returns of 7%+ through to 15% for equity.4 CLOs therefore provide a compelling way to allocate capital across the risk–return spectrum for those investors with a long term approach and a tolerance for complexity.

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