CLOs: The Riskiest Investments in Family Office Portfolios Could be the Most Vulnerable in 2020
Surging capital and dipping yields pushed wealthy investors to riskier assets until last year. Now, the ongoing pandemic and incoming economic crisis could trigger a drastic contraction in the riskiest asset classes in family office and institutional portfolios.
At the epicenter could be an asset class that was rapidly gaining popularity amongst wealthy investors over the past decade: collateralized debt obligations or CLOs. A traditional CLO is a single security backed by a pool of debt. That pool of debt usually includes corporate loans that have low credit ratings. By pooling these loans together, investors could access higher yields for comparatively lower risk. The returns on some equity CLOs could be as high as 20%.
However, with much of the economy suspended and a growing number of businesses on the verge of default, the underlying durability of CLOs could be in doubt. In April, Moody’s Investors Service warned that it may cut the ratings on 859 CLO securities, nearly one in five of the bond securities it rates. S&P Global Ratings said it was reviewing the ratings on 155 CLO bonds, representing 6.5% of its watch list. The Financial Times called CLOs “ground zero for the next stage of the financial crisis.”
A wave of downgrades in the CLO market, which was worth $700 billion at the end of 2019, could hit several noteworthy investor portfolios. The Pritzker family, Bill and Melinda Gates, the family office of Paul Allen, the Huizenga family and the Anschutz family all hold CLOs in their portfolios to varying degrees. Tech billionaire Mark Zuckerberg is also exposed. His multi family office, Iconiq Capital, was a buyer of CLOs in recent years.
A decline in wealth triggered by credit defaults could resurrect the trauma investors experienced during the previous financial crisis.