(Bloomberg) -- Collateralized loan obligations in Europe look appealing as bond spreads grind tighter, according to BlackRock Inc.
"CLO tranches are probably one of the best relative value picks within the credit markets," James Turner, the firm's co-head of European fundamental fixed income investment, said on the latest Bloomberg Intelligence Credit Edge podcast. "You are getting a very good spread and yield pickup there."
CLOs offer an alternative to investment-grade and junk corporate bond markets, which are trading at very thin premiums to Treasuries. They bundle leveraged loans into bonds of varying risk and reward, allowing managers to tailor portfolios to specific investors tolerances.
"Almost every tranche you look at in terms of its spread, it looks well remunerated," said Turner. "Really the chance of credit loss, especially in the higher-rated of tranches, is very very low."
European CLO issuance has already surpassed last year's levels and is on track to beat the all-time high set in 2021. Supply is fueled by spread tightening and low average cost of capital, which have offset the impact of leveraged loan margins spiraling down.
The strong level of activity over the past two years has also allowed the entrance of new managers, and seen a high level of refinancing and resets of existing CLOs.
Despite the compression, Turner says AAA CLO tranches are still attractive at spreads of 125 to 130 basis points, while CLO equity offers "low to mid teens" returns. In addition, the stigma of CLOs that has existed since the global financial crisis — when they were widely confused with collateralized debt obligations — "has more or less passed now," said Turner.
BlackRock's not the only large investment firm chasing CLOs globally. Greg Peters, co-chief investment officer at PGIM Fixed Income, called them "bulletproof," while Lauren Basmadjian, global head of liquid credit at Carlyle, has touted value in mid-market CLOs.
Still, there are signs that risk is building in the leveraged finance market as rates stay high and economic growth slows, with the loan market seen as most vulnerable. In European CLOs, investors have been more concerned about exposure to large capital structures following the default of Altice International, the largest holding in European CLOs, which restructured its debt this year.
Investors can mitigate risk by careful selection of CLO managers, according to Turner. History of credit selection, portfolio diversity and team size are all key factors, he said.
--With assistance from Colin Keatinge.
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