April 28, 2024
WHAT IS CLO EQUITY?
As a complement to a diversified, return-seeking portfolio, investors may want to consider equity in broadly syndicated loan (BSL) CLOs. Investments in the equity portion of a collateralized loan obligation (CLO) can provide a consistent source of income.
A CLO is a special purpose investment vehicle that issues bonds at multiple rating levels and invests the proceeds in a highly-diversified portfolio of BSLs1
The difference between the cost of capital paid to bondholders and the coupons received from loan issuers is the arbitrage, or “arb”
Investors are paid on a quarterly basis according to their seniority in the capital structure, and the arb goes to the equity holders of the CLO. The equity tranche bears the risk of first loss, but also captures the upside
FUNDING SOURCES1
KEY INVESTOR CONSIDERATIONS FOR BSL CLO COLLATERAL
CLO EQUITY: HYBRID DEBT/EQUITY INSTRUMENT
- CLO equity is a “carry” product that is designed to provide quarterly cash-on-cash returns
- 2.9% average quarterly return since 20174
- It can be considered a hybrid debt/equity instrument, given quarterly payments of excess cash flows and the return of capital at end of life
- CLO equity returns have historically shown lower volatility versus public equities
- CLOs are closed-end and non-mark to market vehicles, so intermittent market volatility does not cause forced selling or diverted cash flows
- CLO equity generated a median 20-year realized IRR of 13.1% with a standard deviation of 8.4%5
- Conversely, the S&P 500 generated a 20-year average annual return of 9.8% with a standard deviation of 14.8%6
