CLOs: How to Invest in Mortgage-Backed Securities 2.0

Collateralized Loan Obligations (CLOs) Explained in One Minute: Mortgage-Backed Securities 2.0?

If you have heard of mortgage-backed securities (MBS), you might be familiar with the concept of securitization, which is the process of pooling different types of debt and selling them as a single security to investors. CLOs are a type of securitization, but instead of mortgages, they are backed by corporate loans, often with low credit ratings or high leverage.

CLOs work like this: A CLO manager buys a portfolio of loans from various banks and bundles them into a special purpose vehicle (SPV), which is a legal entity created for this purpose. The SPV then issues different tranches of CLOs to investors, each with a different level of risk and return. The tranches are ranked by seniority, meaning that the senior tranches get paid first from the interest and principal payments of the underlying loans, while the junior tranches get paid last and bear the most risk of default. The CLO manager actively manages the portfolio, buying and selling loans to improve the performance and reduce the losses.

CLOs offer several benefits to investors, such as higher-than-average returns, diversification, and protection from market volatility. However, they also come with significant risks and costs, such as default risk, liquidity risk, interest rate risk, and management fees. CLOs are complex and opaque instruments, and their valuation and rating depend on many assumptions and models. Therefore, investors should be cautious and well-informed before investing in CLOs.

CLOs are sometimes compared to MBS, which were one of the main causes of the 2008 financial crisis. However, there are some key differences between them, such as the quality and diversity of the collateral, the role of the manager, and the regulation and oversight of the market. CLOs have performed relatively well during the COVID-19 pandemic, but they are not immune to shocks and stress. CLOs are not for everyone, but they are an interesting and important part of the financial landscape.

If you want to learn more about CLOs, you can check out these sources:

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