Listen to the latest episode of Credit Exchange with Lisa Lee
Published in London & New York
10 Queen Street Place, London
1345 Avenue of the Americas, New York
Creditflux is an
company
© Creditflux Ltd 2025. All rights reserved. Available by subscription only.
News Analysis
CLO equity funds feel pain from arb and credit jitters
by Paul Conley
It’s been a difficult year for closed-end CLO equity funds. Share prices in the handful of such funds in North America are way down, currently hovering at or near 52-week lows.
Of course, those prices aren’t the sole determinant of how a closed-end equity fund performs, according to Shiloh Bates, CIO at Flat Rock Global. “It doesn’t tell the whole story. [Closed-end equity funds] have very high distributions. If you add in the distributions, the returns look different from just the decline in share price,” he said. “But returns are still abysmal.”
Abysmal indeed. And there are multiple reasons.
Daniel Ko, senior principal and portfolio manager at Eagle Point Credit, a publicly traded closed-end investment company that focuses on CLO equity and trades under the ECC ticker on the New York Stock Exchange, says spread compression is the key factor behind the falling prices.
Tight spreads hurt
“In the past year or so, there has been approximately 25bps of spread compression. CFOs at these loan issuers are doing what they should be doing — repricing and refinancing their loans,” Ko told Creditflux.
“CLO equity has had a really tough year. And there are a few factors,” said Bates. “One is that default rates are elevated. In CLO equity you feel the pain of every single default, and really any loan that trades below 90 cents on the dollar. The second is that loans are repricing tighter. Sometimes you can get that back by refinancing the CLO’s debt tighter as well, but the loans are repricing at a faster rate than people can true up the CLO’s financing cost.”
Ko agrees that the comparatively slow ability of the market to adjust financing costs is a problem. “It would be great if CLO resets and refis could happen as fast as loan repricings, but the CLO market can’t process the resets and refis as quickly.”
Closed end CLO equity funds: share price change YTD (%)
Short of finding a way to speed up CLO resets and refis, the managers of closed-end equity funds are hard-pressed to halt the downward slide in share prices. But time, and the nature of CLOs, may be on the side of ETF managers.
“The main driver in terms of the underlying performance is due to that arbitrage. And this can correct itself very quickly,” said Matthew Layton, partner and head of EMEA at Pearl Diver Capital. “The CLO market has a history of correcting itself because once the arbitrage starts to reduce, the market tends to experience a fall in issuance, and spreads naturally widen out a little bit, which corrects the compression.”
There may be some indications that the tide has turned. Pearl Diver’s closed-end fund, which trades under the ticker PDCC, has dropped 19.56% year-to-date, but is up 0.20% since the start of September. Eagle Point’s ECC is down 30.09% year-to-date, but has been flat since September, down just 0.04% as we went to press.
Oxford Lane Capital, a closed-end fund trading under the symbol OXLC, completed a 1-for-5 reverse stock split on 5 September and then announced it would reduce its monthly dividend by 11.1% to USD 0.08 per share. OXLC shares have dropped 38.66% year-to-date, but are down just 0.19% since the announcement.
By contrast, Sound Point Meridian Capital, which trades under the ticker SPMC, has held its monthly dividend steady at USD 0.25 throughout 2025. Yet its shares have also fallen, dropping 20.43% year-to-date, but rising 0.36% since the start of September.
Complicating matters for equity funds as they look for a turnaround is a sense among investors that something may be amiss in the credit markets.
“Investors are becoming increasingly concerned about credit and the uptick in loan defaults. They’re also seeing an uptick in paid-in-kind interest, which is potentially a precursor to a default,” Bates said.
“Concern doesn’t necessarily mean there’s a problem. But it’s higher on the worry list than it was six months or a year ago.”
Pearl Diver’s Layton suggests that worries about the credit market are misplaced. “I wouldn’t say [there is] ‘concern,’ about the credit markets, but people are pausing for breath,” he said. “There have been headlines recently that those knowledgeable about the industry look at it and think, ‘That doesn’t make sense. That’s a non-headline.’”
Leverage compounds falls
Complicating matters are concerns about the high levels of leverage. “Closed-end fund vehicles employ a lot of leverage,” Bates said. “When things aren’t good, [it] magnifies the problem.”
So what, if anything, can ensure better returns for closed-end CLO equity funds in the months to come? Well, some rate cuts might be nice.
“Lower rates should lead to lower interest costs for the private equity firms, which should lead to more M&A,” said Ko. “And presumably, lower rates should lead to at least one less default or one less LME [liability management exercise] because you have one less company struggling to pay its interest expense and needing to restructure.”
Timing, of course, is everything. That’s as true about pricing CLO resets and refis in a declining-rate environment as it is of anything else.
“If we had priced all of our resets and refis in the first half of the year, we’d be unhappy with some of the prints,” said Ko.
