Volatility, Tariffs, and the CLO Machine, A Global Look with Steve Baker

This week’s episode of Industry Insights: Exclusive Interviews examines the CLO market’s response to 2024’s unprecedented volatility, from April’s tariff announcements to evolving investor dynamics and the emergence of new market participants. Host Julie Miecamp and Managing Editor Hugh Minch sit down with Steve Baker, Global Head of CLO Primary at J.P. Morgan, to dissect what’s really happening in this critical corner of credit markets.

---

Market Volatility and the April Tariff Impact

The CLO market experienced significant disruption following April’s tariff announcements, which caught many participants off guard with their scale and scope. Baker explains how the uncertainty created immediate challenges for a market that relies on stability due to long lead times in deal execution.

“Our market likes stability because we’ve got a long lead time, particularly doing a new issue deal,” Baker noted. “There needs to be a warehouse typically ramping assets, accumulating. Once you have enough assets then you can start the marketing process.”

The volatility manifested in several ways:

• Spread Widening: Primary market spreads widened dramatically in a short period
• Secondary Market Pressure: ETF outflows contributed to selling pressure
• Deal Pipeline Disruption: Some refinancings and resets were paused due to economic challenges

However, the market demonstrated resilience. Unlike a complete shutdown, deals continued to price throughout the volatility, with some investors viewing wider spreads as attractive entry points.

The Japanese Investor Base: A Pillar of Stability

One of the most significant findings from the conversation was the stability of Japanese demand for CLO paper throughout the turbulence. Despite trade tensions between Japan and the U.S., Japanese investors maintained their appetite for the asset class.

“It’s actually held up really well. So there’s still a lot of interest,” Baker observed. “I think there’s still the fundamental reasons why Japan was investing – exposure to floating rates in an asset class that they know very well [and] generate strong returns for the risk.”

This stability has made Japanese investors even more valuable to CLO managers during volatile periods, with numerous managers planning trips to Tokyo to strengthen these relationships.

ETFs: Adding Access and Volatility

The emergence of CLO ETFs represents a double-edged development for the market. While these funds have opened the asset class to a broader investor base – including retail investors – they’ve also introduced new volatility dynamics.

Baker highlighted both sides of this evolution:

• Positive Impact: ETFs have democratized access to CLOs, allowing investors who previously couldn’t access the product to participate
• Volatility Concern: During market stress, ETF outflows can amplify selling pressure when traditional buyers step back

“In periods of volatility, you know, then there was some selling, not massive amounts, but there was some,” Baker explained. “Those ETFs that had to sell, you know, for that selling, they had to find buyers.”

Structural Evolution and Market Maturity

The CLO market’s 30-plus year history has created a foundation of stability that investors value, even as structures continue to evolve incrementally. Baker emphasized how conservative design principles from the market’s early days have contributed to its resilience.

Recent structural developments include:

• Enhanced Tranching: More granular rating levels to meet diverse investor needs
• Static Deals: Shorter-duration structures that appeal to different investor profiles
• Private Credit CLOs: Expansion into the growing private credit market
• Geographic Diversification: Continued growth in European CLO issuance

Regional Opportunities: U.S. vs. European CLOs

The conversation revealed interesting dynamics between U.S. and European CLO markets. While there hasn’t been a massive capital flight from U.S. to European CLOs post-tariffs, European structures offer several advantages:

• Dual Ratings: Two ratings agencies rate every tranche
• Higher Subordination: More conservative capital structures
• Spread Pickup: Approximately 20 basis points when converted to dollars
• Different Underlying Characteristics: Features like less common liability management exercises

Market Outlook: Cautious Optimism

Despite the volatility, Baker maintains measured optimism about the CLO market’s prospects. His confidence stems from several factors:

• Proven Track Record: Strong historical performance across market cycles
• Global Demand: Continued interest from diverse investor bases
• Market Innovation: Ongoing structural improvements and new product development
• Fundamental Value: CLOs continue to offer attractive risk-adjusted returns

However, challenges remain, particularly around underlying loan supply. The market needs stability to drive increased M&A activity and LBO transactions that feed CLO warehouses.

Investor Base Expansion Opportunities

Baker identified several underutilized investor segments that could drive future growth:

European Insurance Companies: Regulatory constraints under Solvency II have prevented European insurers from participating meaningfully, despite U.S. insurance companies being major CLO investors.

Fund Investors: More capital could flow into CLO equity funds and debt funds, particularly given the strong performance relative to private credit fundraising.

Retail Access: ETFs have started this process, but broader retail participation remains an opportunity.

Listen & Subscribe

Listen to the full breakdown on Apple Podcasts, Spotify, Amazon or wherever you get your podcasts.

Produced and edited by two-time Emmy Award-winning producer Tanya Hubbard.