With CLO managers ramping up funds in record numbers, investors have been scrambling to cash in on the diverse investment strategies that make these vehicles a safe choice for yield. However, a recent survey from Fitch Ratings found that these funds may not be as diversified and low risk as their definition would suggest. In fact, CLOs as a whole have been acquiring a high proportion of leveraged loans that are used to fund "shareholder friendly-activities," as well as loans that are light on covenants, and this could mean very unsteady investment platform in the event of a downturn.
Shareholder friendly-activities include leveraged buyouts, mergers and acquisitions and dividend payment capitalizations - activities that Fitch considers potentially riskier transactions than the more benign refinancing. "One of the benefits of the CLO structure is risk reduction, achieved primarily through diversification and overcollateralization. A concentration in shareholder-friendly loans raises the issue of the potential impact on the diversification benefits of the CLO structure," John Schiavetta, group managing director at Derivative Fitch, said in a release.