The biggest buyers of leveraged loans are weakening safeguards that limit how much risk they can take, amping up the potential pain for investors when the economy slows.
The buyers, known as collateralized loan obligations, are beginning to erode protections in their funds that, for example, prevent them from purchasing too many smaller loans that can be hard to sell later on, according to market participants. The CLOs are dialing down these limitations to boost profits for the money managers that put the complicated structures together.
The shifts mean that investments designed to be relatively safe, namely highly-rated bonds sold by CLOs and backed by loans, could end up being riskier than they appear. That has some echoes with structured securities sold during last decade’s housing bubble, which often ended up being stuffed with mortgages that were weaker than investors had expected, even if CLOs are still seen as being far safer than last decade’s collateralized debt obligations.
Read more in Bloomberg.