CLO Equity: 101
From quarterly cashflows to compelling total return potential, CLO equity offers a number of potential benefits. But the asset class is often overlooked, due in large part to its perceived complexity relative to more traditional fixed income investments.
What is CLO Equity?
Collateralized loan obligations (CLOs) are structured vehicles that invest in pools of senior secured loans from corporate borrowers and exhibit a few key characteristics:
- They provide investors access to a highly diverse portfolio of senior secured loans across issuers (typically 150–200 issuers) and industries (typically 15–25).
- They offer transparency, as the underlying holdings are reported to investors on a monthly basis.
- The collateral pools are actively managed by experienced asset managers who have teams to underwrite each of the corporate loans held.
- They have term financing, making them more resilient to changes in the mark-to-market of the underlying collateral, allowing managers to focus on limiting credit risk and increasing value for equity tranche investors.
CLO equity is the common name for the subordinate note (residual tranche) of the CLO structure. This tranche generally receives the residual cash flows generated by the loan portfolio after the CLO debt tranches receive their contracted interest payments. The equity tranche typically represents 8–10% of the capital structure of the CLO, meaning it provides CLO equity investors with 8–10x levered exposure to a portfolio of senior secured loans. This exposure represents a materially lower capital commitment than a direct investment in a senior secured loan portfolio, and also positions investors for potentially higher total returns.
