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Opinion CLOs
Differences in scale and sector exposure mean US and European CLOs offer different risks and rewards
by Thomas Majewski
Thomas Majewski
Founder & managing partner
Eagle Point Credit Management
European CLOs offer more sustainable arbitrage opportunities than US CLOs
Many investors that once invested solely in the US CLO market are now also looking to Europe. Historically, European CLO equity underperformed US CLO equity. Indeed, many Euro 1.0 CLOs failed to deliver 1.0x returns for equity investors, while US CLO 1.0 equity investors enjoyed, on average, roughly 15% IRRs. But the current dynamics in each market may change that mix.
In our view, investors can probably expect better overall returns from CLO 2.0 equity in Europe, and even more dispersion in returns for US CLO 2.0 equity investors.
The European CLO market shares many similarities with the US market — but they also differ in a few key ways. Savvy investors would do well to understand the advantages and disadvantages of both. For starters, there’s scale. In 2024, the US CLO market saw around USD 200bn in new issuance and about USD 220bn in resets. Meanwhile, Europe generated less than a quarter of that, with around EUR 50bn in new issue volume and about EUR 30bn in resets.
US scale fuels volatility and opportunity
In the US, the larger scale brings both a greater set of opportunities and perhaps greater volatility. A more diverse loan market with greater secondary liquidity in the US allows for more differentiation across CLO collateral managers as they express their views on credits. However, when sentiment shifts, the larger and more liquid US loan market experiences more dramatic spread movements and price swings. This dynamic can present the best US CLO collateral managers with opportunities to distinguish themselves through par and spread build. Indeed, in many vintages, the dispersion of US CLO equity returns, while nearly all positive, has varied widely.
Europe’s smaller scale produces the opposite effect: less differentiation among CLO collateral managers, but also inherently lower short-term volatility due to lower liquidity in both the underlying loan and CLO markets. The European loan market tends to have wider loan spreads and has been more resilient in combating spread compression. This perhaps offers European CLO equity investors a sustainable arbitrage opportunity that has disappeared quickly a few times in the more efficient US loan market.
In general, most European CLOs have less tail risk in their portfolios today compared to their US counterparts, particularly when examining the concentration of triple C-rated credits and lower-priced loans. Of course, just because a loan is rated triple C doesn’t mean it is going to default; indeed, many triple Cs ultimately pay off at par. Perhaps they’re refinanced into the private credit market in the US?
Europe has also seen far fewer LMEs, though there are early signs that the trend in Europe is heading the wrong way. The relatively cleaner profile of European collateral portfolios can influence both resilience and return potential, making them a key consideration when comparing CLO risk profiles across regions.
US CLOs are exposed to cyclical sectors
Beyond headline credit metrics, sector composition reveals meaningful differences between US and European CLO portfolios. US CLOs show greater exposure to cyclical sectors like technology, financials and transportation, while European CLOs lean more heavily into defensive areas such as healthcare and services. Notably, US CLOs allocate nearly 15% to technology, versus 11% in Europe, while European CLOs hold a significantly larger share in healthcare, at over 18%, compared to 11% in the US. These variations reflect underlying differences in regional loan markets and issuer bases, but they also shape how CLOs in each geography may respond to macroeconomic shifts. In addition, EU CLOs provide CLO collateral managers with more flexibility in utilising bond buckets, which provides an avenue for differentiation.
There are important geopolitical and policy differences between the US and Europe. This has created a substantial divergence in opportunities between their CLO markets compared with the past few years. The Ukraine war and its impact on the European economy led to a wider gap in European spreads, which piqued interest from crossover investors. Recently, the boost from the potential fiscal stimulus in Europe, coupled with a more uncertain economic environment in the US, has led to renewed interest in the European market and spread tightening. These macro divergences further allow investors to make relative value decisions across both markets.
Each market has notable differentiators — both positive and negative. Investors that can capitalise on moving between these fundamentally different markets should be able to outperform over time.
