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Analysis Private credit
Triple B CLO volatility: beyond the statistics
by Fair Oaks Capital
Triple B/double B corporate strategy may look riskier than triple B corporate bonds over the past 10 years, but our analysis shows the case for adding CLOs is not based on return alone
Annualised volatility is often the single statistic investors reach for when assessing the risk of an investment. On this basis, a triple B/double B CLO strategy may look riskier than triple B corporate bonds over the 10 years since 2016, with a standard deviation of 7.1% against 3.2% for the Bloomberg Euro-Aggregate Corporate Baa index.
We think it is worth looking beyond this measure and beyond the full period, given the particularities of the CLO market.
The track record
Over the full period, the CLO strategy returned 4.0% annualised against 1.1% for triple B corporates, with more volatility, but still offering a higher Sharpe ratio of 0.48 against 0.14, using the German three-month bill as the risk-free rate. Over five, three and one years the picture is even more positive (see chart 1). The CLO strategy’s volatility was similar to or lower than that of triple B corporates and its Sharpe ratio was higher in every period, while triple B corporates had a negative Sharpe ratio over five years and the last year.
2,606
Number of daily observations analysed over a 10-year period
A defining shape
The defining feature of the CLO strategy’s daily returns is their shape. Over 2,606 daily observations since the strategy’s inception in October 2016, the daily return was between -0.05% and +0.05% on 70% of days, against 31% for triple B corporates, and was positive on 71% of days, against 52%. The distribution, however, has larger tails, with moves of more than 1% on 1.6% of days against 0.4%, resulting in an excess kurtosis — a measure of how heavy the tails of a distribution are (zero for a normal distribution) — of 192 against 11.
Over the last five years, the shape is the same but the tails are much smaller. The
CLO strategy’s daily return was between -0.05% and +0.05% on 69% of days against 23% for triple B corporates, it was positive on 77% of days against 49%, and its excess kurtosis falls to 35.
Why are 10 and five years so different?
The difference between the two periods is March 2020. A distribution with tails of this kind should not be summarised by a single standard deviation, as its variance is concentrated in a very small number of sessions, and these have been largely a one-off (see chart 2). March and April 2020 account for 71% of the variance of the CLO strategy’s daily returns over 10 years, against 13% for triple B corporates, while 2020 as a whole, which includes the rebound, accounts for 85% against 17%. Excluding those two months, 10-year volatility falls from 7.1% to 3.8%, against 3.0% for triple B corporates, and excluding 2020 it is 2.9%, below the 3.1% for triple B corporates. One identifiable market dislocation therefore explains most of the strategy’s full-period volatility.
77
%
Proportion of positive days for CLO strategy during the past five years
Except in 2020, the CLO strategy’s daily returns have been consistently steadier and more often positive than those of triple B corporates. In the five, three and one years to October 2026 it was positive on 77-86% of days and between -0.05% and +0.05% on 69-78% of days, against 49-54% and 23-36% for triple B corporates. Across every rolling one-, three- and five-year window since 2016 that excludes March and April 2020, it was positive on more days and moved by 0.05% or less on more days than triple B corporates in at least 97% of windows, and had the higher Sharpe ratio in every five-year window.
Share of 10-year variance of daily returns (%)
Ten year volatility (%)
Price discovery in March 2020
We believe the March 2020 tail is also partly explained by how the two series are priced in stress. CLO secondary valuations are anchored to actual transactions. Bonds are auctioned through bids wanted in competition (BWIC), the clearing levels are disclosed and third-party pricing providers use those traded levels to price comparable bonds across the CLO market. Corporate bond indices rely substantially on evaluated and dealer marks, which academic work has shown can be stale, most of all in stress when trading thins.
In March 2020, with dealer balance sheets constrained, forced sales cleared through BWICs at levels that fed straight into valuations, and once that supply was absorbed the next clearing level could be materially higher, which is consistent with the speed of the recovery.
35
Excess kurtosis of triple B/double B CLO strategy over the last five years
Portfolio efficiency
For an allocator who already owns triple B corporate bonds, the case for adding CLOs is not based on return alone but also on the low correlation of daily returns between triple B corporate bonds and the CLO strategy — 0.21 since inception and 0.05 over the last five years — which makes the CLO strategy a very attractive diversifier. Since inception, a 20% allocation within a triple B portfolio, rebalanced monthly, would have increased the annualised return from 1.1% to 1.8%, with volatility broadly unchanged and a Sharpe ratio of 0.36 against 0.14, and a 50% allocation has a Sharpe ratio of 0.50 (see chart 3). Over five years, a 50% allocation turns the Sharpe ratio of a triple B portfolio from -0.49 to 0.35, with volatility of 2.7%, lower than either triple B corporates or the CLO strategy on its own.
The case for adding CLOs also applies to a high-yield portfolio, where the correlation is 0.42 and the CLO strategy’s annualised return of 4.0% since inception is above the 3.3% for the Bloomberg Pan-European High Yield (Euro) index.
4.8
%
Return for CLO strategy in past year, against -0.5% for triple B corporates
Why this matters now
The comparison matters today given two key risks for investment-grade corporates.
The first is interest rate duration. Triple B corporate bonds are predominantly fixed rate, while CLO notes pay a floating coupon and are largely isolated from interest rate duration risk. The impact has been visible in the last 12 months, when triple B corporates returned -0.5% against 4.8% for the CLO strategy.
The second is supply. Investment-grade issuance has been very heavy this year, driven by AI-related borrowers, and we think continued supply at these levels could put pressure on spreads. CLOs are not immune to this, but the different investor base and supply dynamics of the CLO market mean the risk is lower.
