CLO equity: Not Your Average Asset Class

Summary

Investing in CLO equity can present a compelling opportunity for portfolio diversification and attractive returns. With their front-ended return profile and ability to leverage active management, CLOs can offer significant advantages. The potential for high returns, driven by the excess spread from interest payments and the strategic use of leverage, makes CLO equity a valuable addition to an investment portfolio. 

Moreover, the optionality inherent in CLO structures, such as refinancing, resetting, and redeeming, provides additional avenues for enhancing returns. The resilience of CLOs during periods of market stress, as evidenced by their performance during the global financial crisis and the pandemic, further underscores their robustness compared to other structured finance products. 

CLO equity stands out as a strategic investment choice, offering a blend of high return potential, diversification benefits, and structural advantages that can complement traditional and alternative assets within a portfolio.

Investment risks 
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. 
Structured finance securities such as CLOs entail a variety of unique risks. The performance of a CLO is affected by a variety of factors, including its priority in the capital structure of the issuer thereof, the availability of any credit enhancement, the level and timing of payments and recoveries on and the characteristics of the underlying receivables, loans or other assets that are being securitized, remoteness of those assets from the originator or transferor, the adequacy of and ability to realize upon any related collateral and the capability of the servicer of the securitized assets. Highly rated tranches of CLO Debt Securities may be downgraded, and in stressed market environments, even highly rated tranches of CLO Debt Securities may experience losses due to defaults in the underlying loan collateral, the disappearance of the subordinated/equity tranches, market anticipation of defaults, as well as negative market sentiment with respect to CLO securities as an asset class. 
Many senior loans are illiquid, meaning that the investors may not be able to sell them quickly at a fair price and/or that the redemptions may be delayed due to illiquidity of the senior loans. The market for illiquid securities is more volatile than the market for liquid securities. The market for senior loans could be disrupted in the event of an economic downturn or a substantial increase or decrease in interest rates. Senior loans, like most other debt obligations, are subject to the risk of default. The market for senior loans remains less developed in Europe than in the US Accordingly, and despite the development of this market in Europe, the European Senior Loans secondary market is usually not considered as liquid as in the US The value of investments, and any income from them, will fluctuate. This may partly be the result of changes in exchange rates. Investors may not get back the full amount invested. 
Alternative investment products, including private equity, may involve a higher degree of risk, may engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, may not be required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual portfolios, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. There is often no secondary market for private equity interests, and none is expected to develop. There may be restrictions on transferring interests in such investments. 
The Flat Rock CLO Equity Returns Index seeks to measure the unlevered, gross of fee performance of US CLO equity tranches as represented by the market-weighted performance of the underlying assets of funds that publicly disclose their holdings and fair market values to the U.S. Securities and Exchange commission. The reporting funds satisfy certain eligibility criteria. The index inception date is September 30, 2014. The index is calculated quarterly on a 75-day lag. There were 490 CLO’s reporting as of Sept. 30, 2024.

Invesco disclosures 
This information is not intended as a recommendation to invest in a specific asset class or strategy, or as a promise of future performance. These asset class assumptions are passive, and do not consider the impact of active management. Given the complex risk-reward trade-offs involved, we encourage you to consider your judgment and quantitative approaches in setting strategic allocations to asset classes and strategies. This material is not intended to provide, and should not be relied on for, tax advice. 
References to future returns are not promises or estimates of actual returns a client portfolio may achieve. Assumptions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. Estimated returns can be conditional on economic scenarios. In the event a particular scenario comes to pass, actual returns could be significantly higher or lower than these estimates. 
Indexes are unmanaged and used for illustrative purposes only. They are not intended to be indicative of the performance of any strategy. It is not possible to invest directly in an index.