Insurance Insights Q3 2026: Evaluating AAA CLOs

Introduction

A CLO is a structured finance vehicle that pools together broadly syndicated loans — typically senior secured loans issued by corporate borrowers. The acquisition of these loan assets is financed through the issuance of multiple layers, or “tranches”, of securities. These consist of several classes of debt ranging from senior, highly rated notes to more junior tranches alongside an equity tranche. Each tranche has a defined priority of payment and risk profile.

Cash flows generated by the underlying loan portfolio are distributed by a “waterfall” structure whereby interest and principal payments are first directed to the most senior tranches, while subordinated debt and equity tranches absorb losses before senior investors are affected. This provides substantial credit enhancement to senior and investment grade tranches while junior and equity tranches are compensated for their additional risk with higher return potential.

AAA CLO tranches may offer a compelling blend of attractive yields¹ and no historical credit impairments.² Over the last five years, AAA tranches have delivered yield enhancements significantly above similarly rated corporate bonds, with volatility two to three times lower than broader investment grade markets.³ Importantly, AAA CLOs have maintained a record of zero principal losses, rapid recovery during market drawdowns,⁴ and lower relative correlation to other investment grade asset classes, making them a preferred choice for capital preservation and incremental income for longer term investors.

All these features stem from their structural advantages, (high level of subordination, overcollateralization, and interest coverage), their floating rate and diversified income stream, and overall resilient cash-flow mechanics present in the underlying senior loan market.

As an alternative to either direct investment or a separately managed account (SMA), a CLO ETF can offer insurance investors cost-efficient and diversified access to the market. These ETFs can provide easy access to a diversified pool of CLOs, with daily liquidity and full portfolio transparency — a convenient alternative to the purchase of individual CLO tranches, which requires both substantial security-level due diligence and operational capacity.

A case study for insurers

One of the recurring themes in previous editions of the Insurance Insights newsletter has been the importance of regularly reviewing portfolio allocations. Such reviews should incorporate updated long-term capital market assumptions (CMAs) and assess whether emerging or underutilized asset classes can improve portfolio outcomes across key dimensions, including yield, risk, duration, diversification, and capital efficiency.

In this edition, we examine how an allocation to AAA CLOs may enhance the characteristics of a diversified fixed income portfolio.

Baseline portfolio

Our analysis begins with a hypothetical fixed income portfolio comprising a straightforward mix of government bonds and spread assets. Government bonds primarily serve liability-matching/duration-management objectives, while credit-oriented allocations seek to enhance portfolio yield and generate excess return. Credit exposure is represented through allocations to US investment grade credit, emerging market debt, and a modest allocation to global high yield.

The objective of this portfolio is to broadly align asset duration with liability duration while generating an appropriate level of income to support liability obligations. Depending on product design and liability characteristics, insurers may also allocate to growth assets; however, such exposures are outside the scope of this analysis. For simplicity, we focus primarily on spread risk and foreign exchange mismatch charges, assuming USD as the base portfolio currency.

Portfolio analysis using Invesco Vision

Our keen readers will be familiar with Invesco Vision⁵, our proprietary portfolio construction and decision-support platform, which we use extensively in asset allocation analyses.

Using June 2026 Capital Market Assumptions and/or prevailing market yields where applicable, we first assess the characteristics of the baseline portfolio.

Figure 1 (left) illustrates the portfolio's characteristics from an economic perspective, while Figure 2 (right) evaluates the same portfolio through a Risk Based Capital (RBC) lens. Together, these determine the starting point from which we assess potential improvements arising from alternative asset class exposures.

Evaluating AAA CLOs as a portfolio enhancement tool

Having established the baseline portfolio, the next step is to consider whether additional asset classes can improve the portfolio's overall efficiency. As investors know, strategic asset allocation is often a game of fine margins, and an optimal approach is not simply to focus on another brick in the wall, but to assess other structurally different and complementary building blocks. In this analysis, we focus on AAA CLOs.

Beyond their attractive standalone characteristics, AAA CLOs may offer diversification benefits when combined with traditional fixed income exposures. These diversification effects can, in turn, improve portfolio-level risk-adjusted outcomes and capital efficiency.

To evaluate this potential, we introduce controlled allocations to AAA CLOs and reduce existing exposures to US credit and/or emerging market debt. We then reassess the resulting portfolios using the same capital market assumptions and portfolio analytics framework. Specifically, we examine portfolio scenarios incorporating 10% and 5% allocations to AAA CLOs, funded through adjustments to existing spread asset allocations:

Impact on portfolio efficiency

We then compare the risk-return profiles of the revised portfolios against the original allocation.

Figure 3 (left) illustrates the portfolios from an economic perspective, while Figure 4 (right) evaluates the portfolios under RBC considerations. Notably, even the introduction of a single additional asset class can alter the shape of the efficient frontier and create opportunities to improve portfolio outcomes. As part of this exercise, we also varied allocations to help maintain overall duration characteristics. This highlights an important aspect of strategic asset allocation: portfolio construction is inherently iterative and requires balancing multiple objectives simultaneously rather than optimizing for a single metric.

In this example, the addition of AAA CLOs appears to improve portfolio efficiency by enhancing certain portfolio characteristics while keeping others within acceptable ranges. The precise magnitude of the benefit will naturally depend on assumptions regarding future returns, spreads, volatility, correlations, regulatory treatment, and market conditions. The results should therefore be viewed as illustrative rather than prescriptive.

It is also important to recognize that securitized products receive different risk charge treatments across solvency regimes in Asia. These treatments range from approaches based largely on rating, maturity/duration, like conventional fixed income assets, to frameworks that impose additional capital loadings. As a result, the degree of portfolio efficiency achieved may vary substantially by jurisdiction and should be assessed on a case-by-case basis. Nevertheless, the additional spread typically available on senior CLO tranches may still make them attractive relative to comparable public fixed income assets.

What this analysis does demonstrate is a broader principle of portfolio construction: meaningful improvements in portfolio outcomes do not always require dramatic shifts in asset allocation. More often, value is created through the thoughtful and disciplined introduction of complementary asset classes, combined with targeted adjustments to existing exposures. Effective portfolio construction is usually more about fine tuning than turning the amplifier all the way up to eleven.

Beyond strategic asset allocation

While our analysis focuses on the role of AAA CLOs within a long-term strategic asset allocation framework, their application need not be limited to this context. The availability of AAA CLO exposure through ETF structures also creates potential opportunities for liquidity management and cash deployment strategies. Of course, it should be noted that nobody rides for free – there are some elements of credit sensitivity as well as price volatility that need to be taken into consideration.

Broadly though, insurers may find AAA CLOs useful not only as part of a strategic allocation but also as a complement to broader portfolio and treasury management objectives.

Conclusion

For insurers seeking to enhance portfolio efficiency, AAA CLOs warrant consideration as part of the investment toolkit. Depending on portfolio objectives, risk constraints, and regulatory considerations, they may offer an attractive combination of yield enhancement, diversification benefits, and capital efficiency relative to traditional fixed income allocations. As always, their suitability should be evaluated within the context of the insurer's broader liability profile, investment strategy, and risk appetite.

About Invesco's approach to CLO investing

Invesco’s CLO ETFs are managed by the Private Credit team and can benefit from the platform’s extensive experience in managing both US and European CLO Notes across the rating structure, and the underlying broadly syndicated loans.