What are CLOs? Who is it catered to?

The CLO manager buys loans that are made by financial institutions, often to companies that are below investment grade (rated BB+ or lower). These senior secured loans have priority on company cash flow and are often backed by assets and inventory. The loans themselves act as both the collateral and the revenue stream for the investor in the CLO. By bundling these lower-quality bank loans together (called securitization), the risk in the CLO’s portfolio can be repackaged into securities of a different risk level than represented by the underlying loans. Interest payments received by the CLO from these assets are used to pay investors.

Ownership of CLOs varies by tranche. The least risky, senior-most tranches are mainly owned by banks (which need high-quality capital to meet regulatory requirements) and insurance companies (which favor income-producing investments). The equity tranche is the riskiest, offers potential upside and a degree of control, and appeals to a wider universe of investors. For retail investors, CLOs have been mostly inaccessible, but options are available to gain much desired income from these fantastic devices.