CLO Education Series: The strategic advantage of AAA-rated CLO notes

The strategic advantage of AAA-rated CLO Notes

Kevin Petrovcik:

My name is Kevin Petrovcik and I'm a client portfolio manager and part of Invesco's $48 billion private credit platform. I am super excited to spend some time with you today to discuss some new developments that will now allow easier access to AAA-rated CLO note investments. This is one of the highest yielding investment grade assets and they are AAA. My goal today is to provide you with the following, one, an introduction to CLO notes and a better understanding of how they can be accretive to client's portfolios. And two, a background on Invesco's expertise in CLO note investment and what sets Invesco Private Credit apart from some of our competitors. So let's get started.

Before discussing what a CLO note is, let's spend some time getting to know CLOs. A collateralized loan obligation or CLO is a securitization of a managed portfolio of senior secured leverage loans.

These are the same underlying assets that we've been managing at Invesco Private Credit for the past 35 years.

Corporate issuers will fund regular operations as well as capital market events with these underlying loans. Normal capital market events include things such as mergers, acquisitions, or leveraged buyouts by private equity sponsors. The underlying loans are not securities, but they are rated and typically below investment grade. The loans are floating rate and have a fixed spread over that floating base rate Euribor in Europe or SOFR in the US. While underlying loans are not securities, they're private debt instruments. Investors in loans get the benefit of being senior, secured, and first in line of repayment if anything should go wrong with the issuer.

Now, the CLO structure itself issues securities in the forms of notes and will go out to rating agencies, most likely Moody's, Standard & Poor's, or Fitch to get these notes rated.

Just like any other rated instrument, that rating reflects the likelihood of full repayment of all principal and interest. Each rated note has a different risk profile based on the priority claim of the cash flow of the underlying CLO.

The AAA tranches have priority payment and therefore the lowest risk profile with the strongest structural protection. From a rating agency standpoint, a AAA-rated CLO note has the same default risk as a AAA-rated sovereign or corporate bond. CLOs in their current form have been around for nearly 30 years. One of the key advantages of CLO notes is its high quality floating rate income stream with the highest spreads over traditional AAA assets.

This higher spread and yield has historically resulted in AAA CLO notes outperforming comparable asset classes, but with less volatility. This combination of higher income, lower volatility, and low correlation to traditional asset classes helps diversify an investor's portfolio.

CLOs have various asset coverage and collateral tests that automatically self-correct in periods of stress. To be fair, CLOs are part of a less liquid asset class that can have a higher degree of price volatility during periods of risk-off sentiment. However, the AAA notes offer the highest priority payment on all the underlying corporate credit exposure, which in itself is senior and secured. In fact, over the past 25 years, AAA-rated CLO notes have never defaulted. CLO notes have proven very resilient, and were one of the best performing asset classes throughout the market downturn in 2022, providing diversification from traditional asset classes and outperforming investment-grade bonds by over 16%. Now with a general understanding of CLO notes, let's focus on what differentiates Invesco's approach to managing CLO notes. Invesco leverages the private credit team's 35 years of experience in private credit markets.

Our team has been making investments in rated CLO notes for institutional portfolios for over 25 years.

First, as one of the largest loan managers with over $48 billion in private credit, we are positioned to understand the underlying collateral. Because our CLO note investment team sits alongside our senior loan team, we can incorporate both our knowledge of CLO managers along with our proprietary view of the underlying collateral in order to screen out the lower quality segment of the market. The largest subsector of Invesco's Private Credit platform is managing over $16 billion in underlying CLOs. This place is Invesco as one of the top CLO managers in Europe and the US. Our CLO portfolio managers are the same investors who are making investment decisions on which note to invest in. Not only do we understand what nuances and features to look for when investing in CLOs, Invesco has a well-established relationship with all of the underwriters in order to get good allocations on attractive new issue and secondary opportunities.

Lastly, Invesco has been investing in CLO notes for the past 25 years. We manage almost $2 billion of CLO notes for institutional investors globally, including separate institutional accounts that span over the last 15 years.

In summary, AAA-rated CLO notes represent an overall attractive addition to many portfolios. Relatively high income levels coupled with their low duration create an insensitivity to interest rate changes on their price, structural advantages, and overall low correlation, which really allows them to potentially act as a component of a much larger fixed income portfolio. Invesco's time-tested investment process can work through all the nuances of the asset class and overall work to target high levels of risk-adjusted return. Leaving this potential opportunity in investors' hands. For more information about investing, please contact your local Invesco representative.