CLO Equity Plummets as Returns Plunge Below Zero
AI-generated image · Bay Street Wire
The $1.3 trillion collateralized loan obligation market is experiencing severe deterioration as equity tranche returns plunge, triggering fund disputes and a shift in institutional strategy.
The $1.3 trillion market for collateralized loan obligations (CLOs)—investment vehicles that bundle corporate loans into risk-tiered tranches—is experiencing a severe deterioration in returns, according to reporting from the Financial Post.
While CLOs traditionally generate profit through arbitrage by issuing debt at lower rates than the bundled bank loans they hold, the riskiest portions, known as equity tranches, have seen returns plunge well below zero. Michael Hislop, an analyst at Curasset Capital Management, told the Financial Post that while CLO equity was once highly lucrative, recent underlying loan performance has failed to compensate investors for the risk.
The fallout is manifesting in significant losses for investment firms. One Chicago-based fund with $580 million in assets and heavy CLO equity exposure has seen a 50% decline over the last two years, sparking a feud between its two managers. Other funds with high CLO exposure have warned shareholders of further trouble and reduced dividends.
Institutional investors are increasingly seeking exits. Eagle Point, a Greenwich-based firm known for selecting CLO equity, has shifted its exposure toward equipment financing and infrastructure loans. Eagle Point told the Financial Post the market may be facing a second consecutive year of losses.
Contributing factors to the downturn include a selloff of software debt earlier this year and a lack of new supply caused by a dearth of corporate mergers. Despite these headwinds, the Financial Post reports that exchange traded funds and asset managers continue to demand these bonds, further depressing rates of return.