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Analysis CLO equity
Welcoming in new CLO equity investors
by Lisa Fu & Kathryn Gaw
New investors are committing capital to captive equity funds because they see value beyond pure IRR. But the old guard aren’t happy because projected returns for CLO equity have fallen
A structural shift has taken place, leaving most of the market to accept that return targets for CLO equity have reset to a lower level. But the prospect of smaller returns for the same amount of risk isn’t driving investors away. In fact, CLO equity is getting more attention and more funding than ever before, albeit from a changing cohort of investors.
Historically, third-party investors have been the core funders of CLO equity. They worked closely with managers to print new deals in tandem with loan availability. But the rise of captive CLO equity funds has disrupted this balance.
“CLO equity captive funds have generally had a negative effect on the CLO equity market since their introduction in 2017,” says Daniel Wohlberg, head of CLO issuance and origination at Eagle Point Credit. He notes that captive funds add a “management fee-driven, return-agnostic CLO printing force that increases CLO equity supply at times where more discipline should be applied”.
Projected returns of just 9%
Historical expectations of CLO equity returns were around 15% to 18%, with periods of dislocation pushing those figures up to 20%. But investor sources say these IRR targets are no longer realistic. At least one deal on the primary market offers projected returns as low as 9%, while most IRR targets have been reset down to a range of around 12% to 15%.
Third-party investors have accused managers with captive funds of prioritising new issuance over maximising returns, thus opening the door to these less attractive targets for CLO equity.
“Because of all these captive funds, there’s just too much CLO creation,” says Shiloh Bates, CIO at Flat Rock Global. “Spreads on loans are too tight and CLO financing costs are too high.” CLO debt investors may benefit from a deal with a 9% projected equity return, he says, but such a deal should never have been created in the first place.
Captive funds give CLO managers a patient pool of capital at their disposal to fund the equity position in their own CLOs. To print a new deal, managers no longer need to convince third-party CLO equity investors to step up. In times of market dislocation, this arrangement gives captive players a decided advantage. A manager can scoop up discounted loans and print a new issue, which racks up returns as loan prices recover.
Captive funds also make it easier for managers to issue even when the arb doesn’t work, third-party investors say. This trend has helped push CLO issuance to record levels, to the detriment of CLO equity returns.
Traditionally, when the arb is poor, CLO equity investors pull back and CLO issuance slows. This reduces demand for loans, pushing asset spreads wider, until the arb improves enough to attract CLO equity investors again. But captive CLO equity funds allow for ongoing issuance even during fallow periods, by locking in capital for multiple deals and reducing reliance on more arb-sensitive third-party investors.
Captive CLO equity funds are now larger and more numerous than ever before. In March, Canyon Partners announced USD 400m of commitments for its fourth CLO equity fund, exceeding its initial USD 300m target. A handful have even surpassed the USD 1bn mark. In September 2025, Oak Hill Advisors closed its third CLO equity fund with USD 1.1bn. And in April, CVC’s CLO Equity IV closed with USD 1bn.
You need some sweeteners from the managers
David Altenhofen
Head of investments
Accunia Credit Management
“We started almost 10 years ago with our first [captive CLO equity fund],” says Guillaume Tarneaud, co-head of global liquid credit at CVC. “Ten years ago, the asset class was very niche. No-one really knew about CLO equity.”
The asset class once funded by third-party investors is now seeing an influx of new limited partners seeking exposure via captive CLO equity funds. The broadening LP base, which has been increasing commitments to captive funds, does not appear troubled by subdued return expectations.
“The marketing of captive equity funds over the past 10 years or so has educated family offices, insurance companies, pension funds and sovereign wealth funds, and offered a more liquid alternative to private equity, private credit and other illiquid investments in the alternative investments space,” says Laila Kollmorgen, global head of CLO tranche investments at PineBridge Investments.
Kollmorgen adds that some captive equity funds also opt to sell minority equity in order to stretch out the life of the captive equity vehicle. This can attract an even wider investor base.
CLO equity is being feted as a diversification play for longer-term investors such as pension funds and family offices, some of which are now engaging with the space for the first time, sources say. After all, each CLO provides exposure to some 200 or so companies.
“We’ve seen investors globally look to captive equity vehicles to diversify private equity and private credit portfolios in an asset class with high levels of quarterly cashflow and double-digit targeted returns,” says Stephanie Walsh, head of US CLOs at Bain Capital.
Private equity funds typically target higher returns at around 20%, but they have struggled to generate cash distributions amid a sluggish M&A market. In contrast, CLO equity offers slightly lower returns but comes with the benefit of quarterly cash distributions, according to CVC’s Tarneaud.
“To me, [CLO equity] very much sits in the opportunistic credit bucket or even PE, in terms of fund asset allocation,” he says.
CLO equity is like private equity
Investors can see the similarities between captive CLO equity and private equity funds. Both are long-duration vehicles that require investors to lock up capital, and the fund stakes are illiquid. As private equity confronts its own challenged returns, investors may see better relative value in the cash-returning CLO equity asset class. US private equity’s one-year returns sat at just 8.31% for the 12 months ending 30 September 2025, according to the most recent data from the Cambridge Associates US Private Equity Index.
The Teacher Retirement System of Texas, a US public pension giant overseeing more than USD 225bn, has been comparing CLO equity and private credit on a risk-adjusted basis within its portfolio, CIO Jase Auby previously told Creditflux. Accounting for differences such as fees and leverage, the institutional investor has seen comparable returns from both.
The return profile for CLO equity is unique because it is less dependent on base interest rates compared to an asset class like direct lending, says Robert Klein, president and CIO at Clarion Structured Credit. “For the large cap [liquid credit] that you have underlying CLO portfolios, low-teen returns seem quite attractive,” he says. “Absent fund-level leverage, I don’t think you’re going to get there in direct lending, particularly with lower rates.”
However, for third-party CLO equity investors, absolute return is still what matters. To keep this base engaged, CLO managers are pulling various levers to offset declining equity returns.
Investors globally look to captive equity vehicles to diversify
Stephanie Walsh
Head of US CLOs
Bain Capital
“The cost of capital has come down but the WAS has also come down, making the arb less attractive,” says David Altenhofen, head of investments at Accunia Credit Management. “You need some sweeteners from the managers, and you need the right price.”
Some of these sweeteners include offering a portion of management fees — usually somewhere between 10 and 15 basis points, according to market sources. This option is more common with small or mid-sized lenders. Bank fees are also up for negotiation.
Many third-party investors claim first-day arb is less important than optionality, but they still expect compensation for the risk they are taking by at least a couple of points over the mezz tranches.
“It’s a difficult asset class and it’s getting more difficult,” says Altenhofen.
Some investors have pulled out of CLO equity completely. “Equity returns need to be reflective of the risk taken,” says Kollmorgen. “If the returns are too low, then... captive equity funds won’t be able to raise funds because that capital will be directed to other, more appealing investment opportunities.”
But this is an asset class that shines in times of disruption, and there is no shortage of uncertainty at the moment. In 2021, the arbitrage did not look particularly good but this CLO equity vintage ended up performing very well, CVC’s Tarneaud notes. Russia invaded Ukraine, central banks hiked interest rates and asset dislocation suddenly created opportunities.
For now, market uncertainty is high but the lack of new loans relative to demand continues to be a key issue constraining CLO equity. “The picture can change quickly though,” Tarneaud says. “We’ve seen that time and time again.”
