Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Wealthy Families Use Collateralized Loan Obligations for Yield
Transcript
- Lucas: So there's this corner of the credit market that most individual investors never touch, but ultra-wealthy families have been quietly piling into for the last few years. I'm talking about collateralized loan obligations — CLOs. Luna: CLOs. Those are the things people sometimes confuse with CDOs from the 2008 crisis, right? Lucas: Exactly. And that's the first thing to clear up. A CLO is a pool of leveraged loans — loans made to companies that already have a lot of debt — packaged into tranches with different risk levels. The structure is similar to a CDO on paper, but the underlying assets are different. CLOs hold corporate loans, not subprime mortgages, and they're actively managed. Post-2008 regulation also made them more transparent. Luna: And the appeal for wealthy families right now? Because yields on investment-grade bonds are still relatively modest, even after the rate hikes. Lucas: That's exactly it. As of June 2026, the ten-year Treasury is around 4.2 percent. Investment-grade corporate bonds might get you 5 to 5.5 percent. But a well-structured CLO can offer 8 to 12 percent on the lower-rated tranches, and even the AAA tranche — the safest slice — has been yielding around 6 to 6.5 percent. For a family office looking to generate income without taking on equity-like volatility, that's attractive. Luna: So they're buying yield, but they're also buying complexity. How does a family actually get exposure? Lucas: There are a few ways. Some families buy CLO ETFs or mutual funds — that's the simplest route. But for the ultra-wealthy, especially those with a family office, they often invest directly in the tranches of new CLO issuances. They might work with a CLO manager — a firm like Ares Management, Blackstone, or Carlyle — to get access to the deals. And they'll typically focus on the investment-grade tranches — AAA, AA, or A — for stability, then maybe allocate a smaller piece to the equity tranche for a higher return. Luna: The equity tranche — that's the first-loss piece, right? The riskiest. Lucas: Correct. It absorbs the first losses from any loan defaults, but it also gets the residual cash flows after all the other tranches are paid. In a good credit environment, the equity tranche can yield 12 to 15 percent. But if defaults spike, that tranche can get wiped out. So families who buy equity are typically making a high-conviction bet on the credit cycle. Luna: And where are we in that cycle right now? Mid-2026 — default rates are still low, but there's been a lot of talk about stress in the leveraged loan market. Lucas: Yeah, leveraged loan default rates have been hovering around 1.5 to 2 percent over the past year — very low historically. But there are pockets of weakness: retail and some commercial real estate–adjacent sectors. The good news for CLO investors is that the underlying loans are senior secured — they have first claim on the borrower's assets. So even in a default, recovery rates tend to be higher than for unsecured bonds. Luna: That's a key difference from subprime mortgages, where the collateral was houses whose values were plummeting. Lucas: Right. And CLO managers actively trade the portfolio — they can sell loans that are deteriorating and buy better ones. That active management is a big part of the value proposition. A good manager can add 50 to 100 basis points of return over the life of the deal. Luna: So if I'm a family office, how do I pick a CLO manager? What am I looking for? Lucas: Track record through cycles is number one. You want a manager who has been through 2008, 2020, and the 2022 rate shock. Then you look at their underwriting standards — do they focus on larger, more liquid loans? What's their default and recovery history? And you look at alignment: does the manager co-invest in the equity tranche? That tells you they have skin in the game. Luna: And what about liquidity? CLOs are not something you can sell in an afternoon. Lucas: No, they're not. Most CLO tranches trade in the secondary market, but the bid-ask spread can be wide, especially for the lower-rated pieces. So families typically treat CLOs as a longer-term hold — five to seven years, matching the typical reinvestment period of the deal. That's fine for a family office with a long time horizon, but it's not for someone who might need the cash quickly. Luna: That makes sense. So the typical allocation — maybe 5 to 10 percent of a fixed-income portfolio? Lucas: Yeah, I've seen family offices put anywhere from 3 to 15 percent into CLOs, depending on their risk appetite. And they'll often pair it with other alternative credit — private credit, direct lending, distressed debt — to build a diversified income stream. The key is that CLOs offer a yield pickup without taking on duration risk, because the loans are floating rate. Luna: Ah, that's an important point. Floating rate means if rates go up, the coupon adjusts higher. So CLOs actually benefit from a rising rate environment — unlike long-term bonds. Lucas: Exactly. That's been a big driver of interest over the past few years. And even though the Fed has paused its hiking cycle as of mid-2026, the coupons on CLOs are still resetting based on SOFR plus a spread. So the yields are attractive relative to history. Luna: Let me play devil's advocate. What's the worst-case scenario for a CLO investor in the current environment? Lucas: A sharp recession that triggers a wave of defaults in the leveraged loan market. If default rates spike to 5 or 6 percent, the equity tranche could be completely wiped out, and even the mezzanine tranches could take losses. The AAA tranche would likely survive, but its market value could drop temporarily. That's why diversification across managers and vintages is important — not all CLOs are created equal. Luna: So you're not buying 'CLOs' as a monolithic asset class. You're buying specific deals, from specific managers, at specific points in the cycle. Lucas: Exactly. And the smart families are the ones who build relationships with a handful of top-tier managers and get access to the best deals. There's a big difference between the top-quartile CLO managers and the bottom quartile in terms of net returns. Luna: I've also heard that some family offices are creating their own CLOs — is that a thing? Lucas: It's rare, but yes. A few single-family offices with massive balance sheets — think north of $5 billion — have sponsored their own CLOs. They originate or buy a portfolio of loans, then securitize them and sell the tranches. It's a way to capture the management fee and the excess spread themselves. But it requires a lot of infrastructure and expertise. Most families are better off outsourcing to a dedicated manager. Luna: What about tax considerations? CLOs throw off ordinary income, not capital gains, right? Lucas: Right. The interest payments from CLOs are taxed as ordinary income, which is a disadvantage for taxable accounts. So families often hold CLOs inside a trust or a tax-deferred vehicle — like a family foundation or an IRA — if possible. But for a family office, the yield often outweighs the tax drag, especially if they're in a state with no income tax. Luna: Let's zoom in on a specific deal to make this concrete. Can you give us an example? Lucas: Sure. There was a $500 million CLO issued earlier this year by a top manager — let's call it 'Ares' for illustration. The deal had about 150 senior secured loans, diversified across 30 industries. The AAA tranche, about 60 percent of the capital structure, priced at SOFR plus 130 basis points — so around 6.2 percent. The equity tranche, about 8 percent of the deal, had a projected yield of 13 percent. A family office might put $10 million into the AAA tranche for stability, and maybe another $2 million into the equity for a kicker. Luna: And how did that equity tranche perform through the volatility earlier this year? Lucas: Because default rates stayed low, the equity tranche paid out as expected. But if there had been a spike — say, a couple of large loan defaults — the distribution would have been cut. That's the risk. Luna: So the key takeaway: CLOs are a sophisticated tool for yield, but they require due diligence on the manager, understanding of the structure, and a long-term horizon. Lucas: I think that's right. And they're not for everyone. But for a high-net-worth family that already has a diversified portfolio and wants to squeeze more income out of their fixed-income allocation without piling into junk bonds or private credit, CLOs can be a really efficient way to do it. You just have to know what you're buying. And honestly, that's true of any structured product. Luna: Yeah, I think our audience gets that. By the way, speaking of things that require a little more effort to understand — a quick honest thing. This podcast is ad-free, and that's because a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo. It's what keeps us making episodes like this one, digging into niches that might not get covered elsewhere. Lucas: Yeah, we appreciate that. It's a small group, but it makes a real difference. And we keep the episodes free for everyone. Luna: Totally. Back to CLOs — one thing we haven't touched on is the role of rating agencies. How important are the ratings for CLO tranches? Lucas: Very important, but they're not infallible. The AAA tranche is typically rated AAA by Moody's or S&P, and those ratings have held up well through the 2020 downturn. But investors should still do their own analysis — look at the underlying loan pool, the manager's track record, and the structural features like overcollateralization and interest coverage tests. Luna: So it's not a set-it-and-forget-it investment. Lucas: No, it's not. You need to monitor it quarterly at least. But for families with a dedicated investment team, it's manageable. And the return premium over plain-vanilla bonds can be worth the extra effort. Luna: Alright, so to wrap up: CLOs are a legitimate tool for yield-seeking families, but they're not passive. They require active management selection and ongoing oversight. Lucas: Exactly. And in a world where 4 percent Treasuries are the 'risk-free' baseline, getting 6 to 12 percent with moderate credit risk is a trade many wealthy families are willing to make. Just go in with eyes open.