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June 21, 2024

CLOs – a growing asset class in the Middle East

Lakemore’s view is that the financial landscape is undergoing a transformative shift, with Collateralized Loan Obligations (CLOs) gaining prominence. Some consider it a niche asset class, but over the years CLOs have become a key product in capital allocators’ toolkit. Today CLOs are a trillion-dollar asset class with a broad range of investors. CLOs are structured vehicles with senior secured loans as its assets, while its liability structure comprises of tiered debt with various ratings. A CLO is controlled by the equity tranche and benefits from attractive returns driven by the efficiency of the capital structure.

The growing global and regional CLO market

Over the past decade, the Middle East has witnessed growing interest in CLOs, a trend that has seen high net-worth individuals, family offices, and institutions increasingly allocating parts of their portfolios to this asset class.

CLOs form an integral part of the economy as they keep the credit markets active. They allow banks to recycle capital on their balance sheet, which enables them to continue issuing new loans. As a result, the injection of new capital in the loan market improves liquidity and sustains economic growth.

The senior secured loan market has grown tenfold from US$137 billion in 2002 to $1.4 trillion by 2023 (Source: Pitchbook, LCD, April 2024). Currently, CLOs represent over 70% of the senior secured loan market, underscoring their pivotal role as the primary buyers of senior secured loans. (Source: BofA CLO Factbook, Feb 2024).  

Initially a domain for U.S. and European investors since their inception in the mid '90s, CLOs have gained prominence in the region due to their high-income potential, diversification benefits, and resilience during economic downturns. CLOs’ unique attributes, including robust returns, low correlation with other asset classes, and alignment with long-term capital, make them an attractive investment product.

In the U.S., the CLO market has experienced significant growth, becoming an essential allocation for several types of investors. With the growing sophistication of Middle Eastern investors, CLOs have gained a prominent edge within their portfolio allocation beyond traditional asset classes.

Understanding CLO Equity

The key attribute of CLO equity is that it performs well in volatile or bear market conditions. Compared to other fixed-income investments, CLOs offer floating-rate returns and a wide spectrum of risk-return profiles across its tranches.

The core of CLO equity’s appeal lies in the arbitrage opportunity between the income from the loan pool and the CLO’s cost of borrowing. It enables the CLO to borrow at a low cost of debt and buy assets which pay a higher income. This arbitrage offers collateral managers the ability to deploy diverse strategies to generate attractive income streams for investors, thus positioning CLO equity as a strategic choice for portfolio allocation. 

Pioneering CLO Equity Investments with the Aquatine Platform

Lakemore Partners Ltd boasts its Aquatine platform of funds that specialize in buy-and-hold CLO control equity. With over $1.7 billion in assets under management and an exposure to nearly US$11 billion in senior secured loans through its CLOs, Lakemore Partners’ offering of Sharia-compliant investments in CLO structures underscores its commitment to aligning investment opportunities with regional preferences. The closing of Lakemore’s Aquatine V fund at US$560 million in December 2023 showcases a strong demand from both institutional and global investors.

The Aquatine platform invests in high-quality CLO transactions, securing supermajority equity positions and maintaining control in CLOs managed by top-tier U.S. collateral managers, yielding robust returns. This consistent performance can be attributed to the funds’ capacity for generating healthy and consistent distributions, while maintaining a low default profile compared to the broader loan market. Such resilience and performance are facilitated by the funds’ closed-end, long duration nature, allowing them to weather volatile market conditions.

A standard CLO’s loan portfolio is highly diversified, containing between 200 to 400 loan positions. High demand for CLOs has made access to top-tier collateral managers increasingly competitive. Lakemore’s core team, with experience in the CLO market since its inception and through strategic partnerships with leading collateral managers, enjoys dedicated access to pipeline for deployments. Investors in the Aquatine funds, in turn, benefit from this advantage.

Lakemore Partners is poised to fortify its regional presence, gearing up for a future where CLO investments become a staple in diversified portfolios. This ambition reflects a broader vision for the inclusion of CLOs within financial markets in the Middle East, presenting a promising avenue for diversifying alternative investment strategies.