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News
Volatility returns and opportunity knocks for CLO managers
by Kathryn Gaw & Lisa Fu
The sovereign bond market, where investors typically seek safety, is flashing warning signs as yields for government debt around the globe spike to multi-decade highs. Elevated oil prices are stoking inflation. Amid this, CLO managers appear to be mounting their own defence in an era where no one sector or geography outside of artificial intelligence seems to offer certainty .
In early October, UK gilt yields passed 6% for the first time in almost 30 years, borrowing costs in France and Italy blew out to a two-decade high. The benchmark 10-year Treasuries reached past 5%. Oil prices are above USD 100 a barrel.
Last month, Treasury Secretary Scott Bessent dared credit investors to bet against him, stating: “I am the house now”. They appear to have taken their chances. In early October, Bessent told Axios that “the house doesn’t win every hand” and asked the market to trust the process in the long term. The following day, bond yields rose again.
“I believe that fundamentally, debt markets are weaker because more and more people now believe governments (everywhere in the markets we look at) cannot or will not be fiscally sensible,” says Michael Schewitz, CLO investor at Investec Bank. “If faith is lost in governments’ ability to keep deficits down, then bond rates will rise.”
That’s made CLOs have the upper hand over the sovereign bond market. While historically, nervous investors seek safety in government bonds as a risk reduction tool, a lack of confidence in the political landscape is sending investors on a hunt for diversification instead.In a stroke of good timing, CLO shops have recently been focused on finding ways to diversify their deals even further in an effort to meet new and expected investor demand.
Market participants are even brandishing the term CLO 3.0, separate from the period after the Great Financial Crisis that was dubbed 2.0. From innovative new product structures to trans-Atlantic trading, many of the biggest ideas focused on adding more diversification to the already diversified CLO structure.
The rise of hybrid CLOs
KKR and other behemoth credit firms are looking at doing their own version of Apollo’s AMAPS – a new CLO variant that has been structured to appeal to US insurers, co-managed by Redding Ridge Asset Management. Hybrid private credit/BSL CLOs have already made their debut in the European market, with market participants predicting that many more such issuances will soon follow. Following the success of this structure in the European market, at least one US manager is now looking at issuing a hybrid CLO of their own, in a rare example of European innovation migrating across the ocean.
Multi-currency issuances are also expected to increase, with a USD/EUR denominated print rumoured to be in the offing. This particular currency combination would particularly appeal to US life insurers who are keen to access the diversification and slight yield uptick that Europe has to offer but are stymied by regulatory requirements around currency hedging.
On a recent episode of the Credit Exchange with Lisa Lee podcast, Cindy Beaulieu, CIO of Conning North America, said that CLOs will continue to be a strong area of investments for insurance firms.
“They bring diversification,” she said. “There are really nice attributes of CLOs that are appropriate for insurance portfolios. [They] are a great way to invest in client portfolios and get the combination of quality and, as rates go up, some of that coming through your portfolio as well.”
I am the house now
Scott Bessent
US Treasury secretary
If the macro-economic year to date has been characterised by volatility, the CLO market has been characterised by its resilience. New issuance volumes are likely to reach highs in both the US and Europe (see page five), though that’s come with some widening of spreads.
“The market has experienced a touch of indigestion in recent weeks due to an increase in supply as well as the impact of increasing interest rates,” says Leland Hart, CIO of performing credit at Warwick Capital Partners. “Whether the uptick in spreads sticks will depend on new issue volumes levelling out as well as the consumer continuing to play through rising prices/rates.”
By most accounts, pipeline for the remainder of 2026 looks strong. Furthermore, while CLO managers have openly predicted a rise in defaults, to date this risk has been managed well. Jay Huang, head of structured products investments at CIFC Asset Management, tells Creditflux that he has kept his estimate of the total size of the distressed CLO market to be USD 6bn – the same as earlier in the summer.
“In so far as CLO portfolio have proved resilient this is because of the ‘widgets’ in CLOs, namely senior loans are basically decent products,” says Schewitz. “The loans are senior obligations of these companies and also pay variable rates. The last point means that investors get some interest rate protection at least as a first order effect. Higher rates naturally also mean defaults will increase, but this sometimes takes time to filter through to the lower tranches of CLOs.”
