Collateralised Loan Obligations (CLO) notes are debt securities backed by a mix of bank loans, primarily from BB and single-B rated borrowers. The global market for CLOs has grown to over US$1.3 trillion, with AAA-rated CLO debt becoming a valuable addition to fixed income portfolios. The market for trading CLO notes has become more active in recent years, opening them up as attractive options to investors. Read our full analysis in “The Case for AAA-rated CLO Notes.”
AAA-rated CLO notes can offer many attractive investment features that could complement traditional income portfolios. These features have the potential to enhance risk-adjusted returns in a portfolio:
Offering one of the highest yields among investment grade credit.
Could help reduce volatility during times of interest rate uncertainty.
Focus on the most senior AAA-rated tranche, which has historically never experienced a default.
Low correlation to other asset classes could help improve risk-adjusted returns.
CLO notes are structured with a “cashflow waterfall”, which provides the opportunity for relatively consistent monthly income and yields that are currently higher than other similarly rated fixed income. Furthermore, AAA-rated CLO notes have continued to offer relatively large spread pickup to comparable fixed-rate investments, leading to relatively higher yields. The floating-rate nature of CLO notes help to mitigate risk for investors against interest-rate volatility and duration risk, reducing price volatility and providing a possible hedge against inflation.
Source: Yield represented by Yield to Worst (YTW). US CLO AAA Notes represented by J.P. Morgan CLOIE AAA Index, AAA US Corporates by Bloomberg U.S. Aaa Corporate Index, AAA US ABS by Bloomberg US Agg. ABS AAA Index, Bloomberg US Aggregate Bond Index by US Agg, 1-3 Yr Treasuries by U.S. Treasury: 1-3 Year Index and 1-3 year U.S. Corp by component of the US Agg index. Euro CLO AAA Notes represented by represented by J.P. Morgan Euro CLOIE Index. Euro Agg 1-3yr by Euro-Aggregate: 1-3 Year Index. Euro Securitized AAA by Bloomberg Euro-Aggregate: Securitized - AAA Index. Euro Agg by Bloomberg Euro-Aggregate Index. Euro Corp IG by Bloomberg Euro-Aggregate: Corporate Index. Euro Corp AAA by Bloomberg Euro-Aggregate Corporate Aaa Index and Euro Agg Treasury by Euro-Aggregate: Treasury Index. All Euro indices are hedged to Euro.
An investment cannot be made directly in an index. Past performance does not predict future returns. All data as of 31 December 2024
AAA-rated CLO notes are the most protected, highly rated part of the CLO capital structure. The CLO structure includes various coverage and collateral quality tests to detect and mitigate collateral quality erosion. If these tests are breached, cashflows are redirected to cushion senior note holders and restrict CLO managers’ reinvestment flexibility. This can make AAA-rated CLO notes more attractive during periods of market dislocation, as the structure de-levers and the weighted average life of AAA notes declines.
Historically, AAA and AA CLO tranches have shown resilience, with no material principal impairment reported by Moody’s and S&P over the past decade. The conservative structure of CLOs, especially post-2008 financial crisis, has further strengthened their appeal as a stable investment option.
| Original rating | 1.0 US BSL | 2.0 US BSL | 1.0 European | 2.0 European |
|---|---|---|---|---|
| AAA | 28% | 36% | 30% | 38% |
| AA | 21% | 25% | 23% | 29% |
| A | 15% | 20% | 17% | 22% |
| BBB | 11% | 14% | 11% | 16% |
| BB | 8% | 9% | 7% | 10% |
Source: Ptichbook Data Inc, Intex, Barclays Research as of July 21, 2010, following the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States.
CLO notes have relatively lower correlation to traditional asset classes, enhancing portfolio diversification. The price stability, leading to lower volatility, means that a hypothetical portfolio combinations of AAA-rated CLO notes and traditional fixed income has the potential to improve risk adjusted returns.
Secondary-market liquidity of CLO note has increased significantly over time, addressing a common concern among potential investors. The US CLO note trading volume has more than doubled since 2018, and both US and European CLO markets have shown continued liquidity even during distressed market conditions, such as the onset of COVID-19 in 2020. During the sell-off of risk assets and fixed-rate assets in 2022 and 2023, AAA-rated CLOs were a primary source of liquidity for institutional investors, highlighting their price stability and attractive income.
AAA-rated CLO notes offer a compelling investment opportunity due to their high yields, floating-rate nature, and strong historical performance. With the global CLO market expanding and liquidity improving, these securities provide a valuable addition to traditional income portfolios. Invesco’s expertise and focus on top-tier managers further enhance the appeal of investing in AAA-rated CLO notes, making them a reliable choice for those seeking stability and income in their fixed income investments.
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For complete information on risks, refer to the legal documents.
Value fluctuation: 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.
Credit risk: The creditworthiness of the debt the Fund is exposed to may weaken and result in fluctuations in the value of the Fund. There is no guarantee the issuers of debt will repay the interest and capital on the redemption date. The risk is higher when the Fund is exposed to high yield debt securities.
Interest rates: Changes in interest rates will result in fluctuations in the value of the fund.
Liquidity risk: It may be difficult for the Fund to buy or sell certain instruments in stressed market conditions. Consequently, the price obtained when selling such instruments may be lower than under normal market conditions.
CLO Debt Securities Risk: 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 U.S.
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