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Opinion CLOs
CLOs that refinanced in 2024 are set to take advantage of market turbulence
by Thomas Majewski
Thomas Majewski
Founder & managing partner
Eagle Point Credit Management
There are opportunities for CLOs to build par through discounted purchases
Perhaps ‘Liberation Day’ should have been called ‘Volatility Day’? Since that day in early April, markets have moved in both directions — sometimes violently. The introduction of significant new tariffs — followed by multiple amendments to the tariff policies — has made even short-term capital planning difficult for many businesses.
I can’t imagine a company committing to build a new factory anywhere in the world right now. Will your raw materials become subject to a large new tariff making it uneconomical to produce? What about your output? It has become almost impossible to make a prudent long-term capex decision.
Expect a hit to growth in the short term
Early April economic indicators weren’t that bad. That said, the multiplier effect from capital spending in the economy is real and changes in behaviour take time to flow through to economic data. What will economic statistics looks like for May or June? No one knows for sure, but it’s hard to be bullish on economic growth in the short-term.
While many markets may loathe uncertainty, CLOs can find opportunity. What makes CLOs particularly well-suited to navigate — and benefit from — today’s volatility, is their fundamental structure, which is designed to keep reinvesting with non-mark-to-market financing. Unlike many other leveraged fixed-income instruments, CLOs aren’t required to sell assets or post margin when prices decline temporarily.
While other market participants may become forced sellers to meet liquidity needs (we’re looking at you, ETFs) or internal risk limits, CLO collateral managers can remain on the offensive, focused on fundamental value rather than short-term price movements. In fact, experienced CLO collateral managers can capitalise on short-term price movements.
In addition, many in the CLO market spent the past year preparing for this moment. During the 2024 tightening of CLO debt spreads, hands-on CLO equity investors took advantage of favourable market conditions to reset or refinance their structures, extending reinvestment periods and locking in attractive, bull-market financing terms. While we had to face loan spread compression, which definitely hurts, we were able to lock in long-dated liabilities that are now handsomely in the money.
CLOs with long reinvestment periods remaining can now play offense. Before the market volatility kicked off in February, approximately 65% of the loan market was trading above par. Since February, nearly all of the loan market is trading at a discount, offering plenty of opportunities for CLOs to make relative value swaps and build par through discounted purchases. The loan repricing wave we lamented last year is also ancient history, and we expect loan spreads to widen, improving CLO equity arbitrage.
As we navigate these choppy markets, it’s worth remembering that volatility — however intense — is rarely permanent. Markets eventually find equilibrium, fear subsides and prices typically revert toward fundamental values. In credit, the rumour is always worse than the news. The current volatility, which is driven by tariff policies and subsequent market reactions, will eventually stabilise as businesses and markets adapt to the new normal.
Prepare for long-term outperformance
CLO investors, take heart: while volatility creates undesirable short-term price movements in our investments, it also creates a unique window for real value creation. By understanding the structural advantages of CLOs and selecting those CLO collateral managers which have the DNA to capitalise on market dislocations, long-term equity investors can transform today’s uncertainty into tomorrow’s outperformance.
What are you doing with your CLO equity portfolio?