STRUCTURED WEEKLY: CLO Correlation Risk May Sneak Up on Buyers

Collateralized loan obligation investors may face a rising threat posed by an overlooked knock-on effect of the pandemic.

Correlation risk, which is the likelihood that loans will default at the same time, is being underestimated by CLO investors, according to risk adviser EAB Investment Group. This suggests that diversification of the underlying pools of leveraged loans that make up the securities may be less of a defense to the downturn than assumed.

“People aren’t prepared for the possibility that CLO intra-asset portfolio correlations may have broken down,” EAB global macro strategist Arnim Holzer said in an interview. “The Covid ...