Jeff Reemer
As we look towards 2026, consensus expectations are for continued rate cuts. How do you think CLO equity will behave in a declining rate environment?
Ian Gilbertson
I'm glad you asked, Jeff, because this is a question that we get a lot from potential investors.
The concern is understandable; leverage loans are floating rate assets.
And the fear is that declines in interest rates could affect the base rates of these vehicles typically so far in the US or Euribor in Europe. And that could lead to those lower quarterly distributions we discussed.
However, CLO equity is unique within the CLO structure because it’s essentially quasi fixed rate. Distributions are driven by the difference between the spreads on loan assets and the spreads on debt liabilities, both of which are floating rate but tied most of the time to the same benchmark.
So while there may be short-term fluctuations, quarter to quarter rate movements alone up or down typically do not cause large shifts in distributions. In fact, in low-rate environments, the median annual distributions of 13.6% in the US and 15% in Europe may appear even more attractive relative to the broader fixed income universe.
Jeff Reemer
In the current macroeconomic environment, what are the key factors driving CLO equity performance?
Ian Gilbertson
Throughout 2025, the market has been really focused on defaults and credit losses, a trend that began in 2023 when we saw an uptick in interest rates.
This year, investors initially had to digest tariff impact, and the implication that could have on loan portfolios, but has shifted their attention to some notable defaults within the private credit space.
Currently, annualized loan default rate, including distressed exchanges, is about 3.3% in the US loan market. So partnering with a manager that has a strong track record of credit selection, and a proven platform is critical. Importantly, the debt market tends to reward these tier one managers by accepting lower financing costs on their debt liabilities, which can further enhance the cash flows that get generated to CLO equity investors.
As we look ahead to 2026 and the potential for declining interest rates, many investors are considering how CLO equity may perform in such an environment. While lower rates raise questions about distribution levels—given that leveraged loans and CLO liabilities typically reset with market benchmarks—CLO equity often behaves more like a quasi‑fixed‑rate investment. That’s because distributions are largely determined by the spread between loan asset yields and debt costs, which tend to move in parallel, helping to keep income relatively steady.
In this discussion, Ian Gilbertson, Co‑Head of US CLOs, underscores the importance of strong credit selection and active management as market conditions evolve, including recent default patterns and the effects of tariffs. He also notes that working with experienced managers could provide access to attractive financing terms and may contribute to maintaining strong returns for CLO equity investors, despite changes in the broader macroeconomic environment.
We are a leading, long-tenured private credit manager, using a conservative credit process to pursue opportunities across syndicated loans, direct lending, distressed debt, and special situations.
CLO equity offers institutional investors the potential for competitive income, diversification, and growth, enhancing portfolios beyond traditional fixed income and private equity.
Discover how CLO equity investors manage downside risk and leverage market volatility through active credit risk strategies.
CLO equity stress tests show strong returns even in stress, aided by widening spreads, low financing costs, and refinancing benefits.
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Source: JPMorgan Default Outlook 13 November 2025.
All data sourced to Invesco unless otherwise indicated. As of September 30, 2025.
Investment risks
Investments in private credit and private debt—including leveraged loans, middle market loans, mezzanine debt, and second liens—are speculative and involve significant risks. These securities are generally illiquid, lack a secondary market, and may need to be held to maturity, which can result in liquidity constraints and difficulty exiting positions. Borrowers often have high leverage, increasing default risk, particularly in adverse economic or interest rate environments. Competitive pressures and excess capital may lead to weaker underwriting standards, raising credit risk and reducing potential recoveries. Private market investments also carry risks related to limited transparency, higher fees and expenses, longer investment horizons, and regulatory considerations. Additionally, these securities may be sold or redeemed at values different from the original investment amount and are considered to have speculative characteristics similar to high-yield securities. Issuers are more vulnerable to changes in economic conditions than higher-grade issuers, and investors may face liquidity strain from capital calls during periods of market stress. These factors can materially impact investment performance and principal value.
Structured finance securities such as Collateralized Loan Obligations (CLOs) entail a variety of unique risks. The performance of a CLO is affected by a variety of factors, including its priority in the capital structure of the issuer thereof, the availability of any credit enhancement, the level and timing of payments and recoveries on and the characteristics of the underlying receivables, loans or other assets that are being securitized, remoteness of those assets from the originator or transferor, the adequacy of and ability to realize upon any related collateral and the capability of the servicer of the securitized assets. Highly rated tranches of CLO Debt Securities may be downgraded, and in stressed market environments, even highly rated tranches of CLO Debt Securities may experience losses due to defaults in the underlying loan collateral, the disappearance of the subordinated/equity tranches, market anticipation of defaults, as well as negative market sentiment with respect to CLO securities as an asset class.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. This should not be considered a recommendation to purchase any investment product. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please obtain and review all financial material carefully before investing.
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