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Exploring the key features of AAA-rated CLO notes

3 March 2025
Invesco
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Collateralised Loan Obligations (CLO) notes are debt securities backed by a mix of bank loans, primarily from BB and single-B rated borrowers. The global market for CLOs has grown to over US$1.3 trillion, with AAA-rated CLO debt becoming a valuable addition to fixed income portfolios. The market for trading CLO notes has become more active in recent years, opening them up as attractive options to investors. Read our full analysis in “The Case for AAA-rated CLO Notes.”

Key features of AAA-rated CLO notes

AAA-rated CLO notes can offer many attractive investment features that could complement traditional income portfolios. These features have the potential to enhance risk-adjusted returns in a portfolio:

High quality income:

Offering one of the highest yields among investment grade credit.

Floating rate feature:

Could help reduce volatility during times of interest rate uncertainty.

Structural advantages:

Focus on the most senior AAA-rated tranche, which has historically never experienced a default.

Diversification benefits:

Low correlation to other asset classes could help improve risk-adjusted returns.

High income and floating rate feature

CLO notes are structured with a “cashflow waterfall”, which provides the opportunity for relatively consistent monthly income and yields that are currently higher than other similarly rated fixed income. Furthermore, AAA-rated CLO notes have continued to offer relatively large spread pickup to comparable fixed-rate investments, leading to relatively higher yields. The floating-rate nature of CLO notes help to mitigate risk for investors against interest-rate volatility and duration risk, reducing price volatility and providing a possible hedge against inflation.

Yield to Worst and Duration Comparison

Source: Yield represented by Yield to Worst (YTW). US CLO AAA Notes represented by J.P. Morgan CLOIE AAA Index, AAA US Corporates by Bloomberg U.S. Aaa Corporate Index, AAA US ABS by Bloomberg US Agg. ABS AAA Index, Bloomberg US Aggregate Bond Index by US Agg, 1-3 Yr Treasuries by U.S. Treasury: 1-3 Year Index and 1-3 year U.S. Corp by component of the US Agg index. Euro CLO AAA Notes represented by represented by J.P. Morgan Euro CLOIE Index. Euro Agg 1-3yr by Euro-Aggregate: 1-3 Year Index. Euro Securitized AAA by Bloomberg Euro-Aggregate: Securitized - AAA Index. Euro Agg by Bloomberg Euro-Aggregate Index. Euro Corp IG by Bloomberg Euro-Aggregate: Corporate Index. Euro Corp AAA by Bloomberg Euro-Aggregate Corporate Aaa Index and Euro Agg Treasury by Euro-Aggregate: Treasury Index. All Euro indices are hedged to Euro.

An investment cannot be made directly in an index. Past performance does not predict future returns. All data as of 31 December 2024

Structural advantage

AAA-rated CLO notes are the most protected, highly rated part of the CLO capital structure. The CLO structure includes various coverage and collateral quality tests to detect and mitigate collateral quality erosion. If these tests are breached, cashflows are redirected to cushion senior note holders and restrict CLO managers’ reinvestment flexibility. This can make AAA-rated CLO notes more attractive during periods of market dislocation, as the structure de-levers and the weighted average life of AAA notes declines.

Historically, AAA and AA CLO tranches have shown resilience, with no material principal impairment reported by Moody’s and S&P over the past decade. The conservative structure of CLOs, especially post-2008 financial crisis, has further strengthened their appeal as a stable investment option.

Credit enhancement increased post-GFC

Original rating 1.0 US BSL 2.0 US BSL 1.0 European 2.0 European
AAA 28% 36% 30% 38%
AA 21% 25% 23% 29%
A 15% 20% 17% 22%
BBB 11% 14% 11% 16%
BB 8% 9% 7% 10%

Source: Ptichbook Data Inc, Intex, Barclays Research as of July 21, 2010, following the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States. 

Diversification

CLO notes have relatively lower correlation to traditional asset classes, enhancing portfolio diversification. The price stability, leading to lower volatility, means that a hypothetical portfolio combinations of AAA-rated CLO notes and traditional fixed income has the potential to improve risk adjusted returns.

Are CLOs liquid?

Secondary-market liquidity of CLO note has increased significantly over time, addressing a common concern among potential investors. The US CLO note trading volume has more than doubled since 2018, and both US and European CLO markets have shown continued liquidity even during distressed market conditions, such as the onset of COVID-19 in 2020. During the sell-off of risk assets and fixed-rate assets in 2022 and 2023, AAA-rated CLOs were a primary source of liquidity for institutional investors, highlighting their price stability and attractive income.

Conclusion

AAA-rated CLO notes offer a compelling investment opportunity due to their high yields, floating-rate nature, and strong historical performance. With the global CLO market expanding and liquidity improving, these securities provide a valuable addition to traditional income portfolios. Invesco’s expertise and focus on top-tier managers further enhance the appeal of investing in AAA-rated CLO notes, making them a reliable choice for those seeking stability and income in their fixed income investments.

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    Value fluctuation: The value of investments, and any income from them, will fluctuate. This may partly be the result of changes in exchange rates. Investors may not get back the full amount invested.

    Credit risk: The creditworthiness of the debt the Fund is exposed to may weaken and result in fluctuations in the value of the Fund. There is no guarantee the issuers of debt will repay the interest and capital on the redemption date. The risk is higher when the Fund is exposed to high yield debt securities.

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