Real Conversations → Inside Credit: Rates, CLOs, and the Next Phase of the Cycle w/ Ross Burnaman

Key Concepts

• CLLOs (Collateralized Loan Obligations): Investment vehicles backed by a pool of loans, typically senior secured corporate loans. They are structured into tranches with varying levels of risk and return.
• Eldridge: An insurance and asset management holding company with significant expertise in credit investing, managing $70 billion in assets.
• Sector Expertise: Eldridge’s approach to credit investing focuses on deep understanding of specific industries (e.g., tech, manufacturing) rather than solely relying on macroeconomic forecasts.
• Credit Selection: The process of carefully choosing loans for inclusion in CLLOs, prioritizing quality and avoiding potential defaults.
• Structural Protection: The built-in safeguards within CLLOs, such as equity cushions and subordination, that absorb losses and protect investors.
• Macro Tourists: Investors who react to headline events without a deep understanding of underlying credit fundamentals.
• Floating Rate Loans: Loans with interest rates that adjust based on a benchmark rate, providing protection against rising interest rates.
• Core Plus Allocation: A portfolio strategy that combines core fixed income investments with higher-yielding, riskier assets like CLLOs.

Eldridge and the CLLO Landscape

Eldridge, a $70 billion asset management firm, has a strong foundation in credit investing, representing over 50% of their AUM. Founded by Todd Bolley and Tony Manella (formerly of Guggenheim), and bolstered by industry veterans like Jeff Furr and Nick Sandler, Eldridge’s credit division is structured into four units: corporate credit, asset-based financing, structured credit (CLLOs), and real estate credit. While not the largest part of their AUM, credit is central to Eldridge’s strategy. They’ve been actively involved in credit investing for a considerable time, predating the recent ETF offerings (CLOX and CLZ) which provide broader access to their expertise.

Eldridge’s Credit Investment Approach

Eldridge’s credit strategy is characterized by a sector-focused approach. Instead of organizing teams around loan types (secured vs. unsecured), they group analysts by industry (tech, manufacturing, etc.). This allows for deeper understanding of company-specific risks and opportunities. This bottom-up analysis is combined with a top-down macroeconomic view to assess sector performance. The firm emphasizes credit selection, leveraging its in-house loan investing platform and CLLO management expertise to identify and avoid potentially problematic loans. They prioritize understanding the fundamentals of each company and its industry, rather than relying solely on market signals.

Understanding CLLOs: Structure and Protection

A CLLO is a securitization of a pool of 250+ senior secured loans. These loans are typically from mid-sized companies, representing a significant portion of the US economy. The CLLO is divided into tranches (AAA, AA, A, Triple B, Double B, Equity) with varying levels of risk and return. Eldridge focuses on investing in the Triple B and Double B tranches, benefiting from substantial credit enhancement. Key structural protections include:

• Equity Cushion: An 8-12% equity layer absorbs initial losses, protecting higher-rated tranches.
• Diversification: Exposure to a large pool of loans (over $110 billion in CLZ) reduces concentration risk.
• Manager Expertise: Experienced CLLO managers actively select loans and reinvest proceeds, aiming to buy loans at a discount and benefit from par redemption.
• Floating Rate Nature: The underlying loans are typically floating rate, mitigating interest rate risk.

Navigating Credit Events: First Brands & Tricolor

Recent credit events involving First Brands and Tricolor were used as case studies. Eldridge had previously passed on investing in both companies due to identified irregularities and concerns about their financial statements, ultimately avoiding losses when these companies faced fraud allegations. This highlights the importance of rigorous due diligence and proactive credit selection. Even if these events had impacted CLZ, the diversified nature of the portfolio (less than 0.25% exposure to First Brands) and the substantial equity cushion would have limited the impact. The example illustrates that CLLO’s are designed to absorb idiosyncratic credit events without significantly affecting overall performance.

Macroeconomic Considerations & the Rate Cycle

While acknowledging the importance of macroeconomic factors (rate cycles, economic growth), Eldridge emphasizes a bottom-up approach to credit analysis. They believe that focusing on individual company fundamentals and sector dynamics is more crucial than reacting to broad market narratives. The discussion highlighted the recent “quad four” economic environment (slowing growth and inflation) and the overreaction in the BDC market as examples of “macro tourists” misinterpreting credit risk. The firm believes that the current environment, with a stable rate outlook, is favorable for CLLO investments.

CLLO vs. High Yield Bonds: A Key Distinction

A key distinction was made between CLLOs and traditional high yield bond funds (like HYG). CLLOs offer several advantages:

• Higher Yield: CLLOs typically offer a higher yield (currently around 7.5% for CLZ) than high yield bonds.
• Lower Volatility: CLLOs exhibit lower price volatility due to the structural protections and diversification.
• Floating Rate Protection: The floating rate nature of the underlying loans protects against rising interest rates.
• Manager Expertise: CLLOs benefit from the active management of experienced credit professionals.

Portfolio Allocation & Future Outlook

CLLOs are positioned as a “core plus” allocation within a diversified portfolio. They provide a higher yield than core fixed income investments while offering structural protections against credit risk. Eldridge believes that the current market environment, with relatively muted credit stress and a stable rate outlook, is favorable for CLLO investments. They anticipate that the benefits of CLLO’s – diversification, structural protection, and manager expertise – will continue to drive performance. The firm also noted the potential for AI-related credit risks, emphasizing the importance of focusing on companies with stable, predictable cash flows.

Conclusion

Eldridge’s CLLO ETFs (CLOX and CLZ) offer investors access to a sophisticated credit strategy backed by decades of institutional expertise. The firm’s sector-focused approach, rigorous credit selection process, and emphasis on structural protection differentiate their offering from traditional high yield investments. By focusing on fundamentals and avoiding “macro tourism,” Eldridge aims to deliver consistent, risk-adjusted returns in the CLLO market. The key takeaway is that CLLOs, particularly those managed by experienced teams like Eldridge, can provide a valuable addition to a diversified portfolio, offering a compelling combination of yield, protection, and diversification.