CLOs overcome April showers with rapid recovery — Q2 25 CLO fund returns (9fin)

Michelle D’souza and Sam Robinson 

*No exit fees on fund **Structured as closed-end funds †Fund has quarterly NAV/liquidity broken down into monthly returns ††Fund has at least some marked to model component. All returns net of fees. Some March returns include estimates. For a download of returns please click here.

CLO fund performance demonstrated resilience in Q2 2025, marked by a drop-off in April swiftly followed by a strong recovery. CLO funds that target equity, for example, posted an average of -2.16% in April, but ended the quarter with average returns of 2.04% across the whole period.

Both primary and secondary CLO markets have been active. Despite tariff turbulence, the US BSL market brought $87.4bn of pricings in Q2, down less than a fifth from the same period in 2024 (a record year), in which there was $107bn of primary activity. And in Europe, despite a pause in the market for most of April, there were €20.6bn of pricings, up from €18.2bn in the 2024 period.

Despite initial volatility and spread widening after ‘Liberation Day’ (2 April), spreads across the cap stack tightened in the latter half of the quarter, although senior tranches lagged. European CLO triple-As are now seen as attractive compared to US BSL CLO triple-As on a rate and currency-hedged basis, with rising interest from Japanese investors, according to sources.

There has also been strong secondary CLO market activity. According to Citi CLO research, European CLO IG BWIC volumes were up 10% year-on-year at €4.5bn, although non-IG and equity volumes have dropped 28% year-on-year, to €2bn. CLO DNT rates spiked to 16% for IG (versus 7% LTM average) and 19% (16%) for non-IG during Liberation Day, as the market entered a price discovery mode.

In a wider view, the CLO market remains attractive versus other ABS products. According to Citi Research, CLO triple-As offer a 53bps spread pickup over Dutch Prime triple-As and a 26bps spread pickup over UK Prime triple-As. CLO triple-Bs are also offering attractive spread pick-ups to double-B rated high yield, with double-B rated loans trading 15bps wider than CLOs at the end of June.

Post Liberation Day

As already hinted, the tariff-induced volatility immediately following Liberation Day had an impact on CLOs as it did the rest of the financial market, although there were also opportunities for canny CLO investors.

Nishil Mehta, head of structured credit investments at Carlyle Group, told 9fin his firm capitalised on post-Liberation Day volatility by opportunistically buying CLO double-B tranches in the secondary market at discounted prices. These positions rallied to par over the quarter.

“While relative value between primary and secondary markets shifted as the market rallied, we continue to actively assess relative value,” he explained.

“We increased exposure to European CLO double-Bs as they offer a healthy spread pickup versus similar profile US CLO double-Bs. We believe the spread pickup is adequately compensating investors for decreased liquidity in the European market.”

Ron Zeltzer, portfolio manager at Valeur Group, said the firm executed five primary trades in June, all in single-B tranches, which now account for 12% of the portfolio, up from zero the previous month.

“These new positions now offer yields around 11%, backed by clean collateral and strong structural protection,” he said. “At the same time, we exited a legacy double-B position with limited upside. Elevated spreads in single-Bs, driven by shallow investor depth and an outsized share of new supply, created compelling relative value. These trades boosted our portfolio yield, with only a modest increase in duration.”

While post-Liberation Day opportunities may have been short-lived, some managers found supply through fund liquidations.

“Liquidations of a couple of closed-ended funds have helped in terms of supply, either via BWIC or bilaterally,” said one CLO investor. “One manager started selling in February, a little bit in March, but then stopped and has now started again. We’re not talking about selling at distressed prices.”

The CLO ETF market also held firm despite volatility.

“There was previously concern that large ETFs might amplify volatility, but there was always a buyer. It wasn’t messy,” a mezzanine investor noted. “Of course, there was some price movement, but compared to other situations, it was orderly. The market digested it well, with no major forced selling or drama.”

Meanwhile, the European CLO ETF space continued to grow, intensifying competition. BlackRock expanded its platform with the launch of the iShares € and $ AAA CLO Active UCITS ETFs, both focused on triple-A CLO tranches. Following this, Invescoannounced a fee reduction on its CLO UCITS ETFs — from 0.35% to 0.25% annually, effective 24 July 2025. Similarly, the Janus Henderson Tabula EUR AAA CLO UCITS ETF also appears to have cut its annual fee to 0.25%.

This evolving landscape has also raised the possibility of CLO ETFs looking further afield in Europe.

“The recent mezzanine tightening in euro CLOs stems from investors scrutinizing the primary equity arbitrage,” one investor said. “We’re seeing growing ETF demand lower down the capital stack, not just in triple-As.”

Positioning for H2

The picture looks a lot rosier now for CLOs than it did in April, but questions on arbitrage, spread tightening and a potential re-emergence of macro volatility remain.

Olivier Gozlan, portfolio manager at Crystal Funds, emphasised that, while short-term performance is favourable, current discount margins are at all-time tight levels, indicating potential risks ahead.

“When you look at the last 5-10 years of historical discount margins, it’s clear that we’re currently at an all-time tight. In terms of short-term performance, the market is favorable, allowing for decent trading and returns.”

“However, when thinking about the next cycle, it’s important to position your portfolio not just for short-term gains, but also for medium-term performance,” added Gozlan. “Given that spreads are currently tight, we need to be prepared for potential widening.”

For firms sensitive to mark-to-market fluctuations, Gozlan says it’s crucial to choose tranches that will be less impacted by price movements.

“One way to partially hedge against volatility is by buying high-coupon tranches, as they tend to be less sensitive to market fluctuations and offer more stability,” he said. “We’ve employed this strategy for various reasons. A major opportunity we saw in the first half of the year was in short-duration paper, which is typically high-coupon and much less vulnerable to spread widening.”

Despite these active strategies, some investors remain cautious, particularly those looking to build cash reserves.

“Right now feels like time to have a little more cash, and wait and see what kind of supply picture forms in September, what the fundamentals are doing, what the macro is doing,” said an investor.

Refinancing and reset activity continues to be a major theme in the CLO market. In Europe, Citi CLO Research maintained its €50bn refi/reset target for the year, estimating €50bn of European CLOs will be in the money to either refi or reset by the end of 2025. This is especially true for the 2023 vintage, where half of those deals are expected to be reset or refinanced.

Some investors are opting to bypass resets amid relative value.

“Managers have reset deals and managed to get very tight spreads,” said another investor. “We need arbitrage, so most of the times, it has made more sense to not participate in resets and buy in the secondary market where you can find wider spreads.”

Shifting landscapes

Mehta anticipates further tightening in loan spreads, although repricing activity has moderated over Q2. He also highlighted the potential risks from tariffs, noting that, while the direct impact on the loan market is limited, about 5-10% of borrowers have medium-to-high tariff exposure.

“We are more focused on the indirect impacts of tariffs, and the implications of how a broader slowdown in the global economy could stress borrowers that are already struggling or over-levered. In this situation, we would anticipate a potential increase in loan downgrades and defaults,” he said.

By the end of the quarter downgrades were off the peaks seen in 2024, but they still outpaced upgrades, and average triple-C buckets for reinvesting CLOs stood at 4.5% and 3.8%, for US and Europe, respectively, according to data from 9fin and Moody’s Analytics.

Sources also indicate possible volatility due to shifting regulatory landscapes, geopolitical tensions, and uncertainty around the Fed’s policy decisions. Based on the outlook for volatility in the second half of the year, Mehta says the firm has defensively positioned its portfolios to allow them to be more aggressive in periods of volatility, similar to what they did following Liberation Day.

Despite the potential for near-term volatility, he believes CLO debt spreads could tighten further, though they will remain attractive compared to investment-grade and high-yield bonds.

Typically, there is often portfolio rebalancing in September and December, which could also lead to volatility. However, Gozlan says he does not foresee any major catalysts for large spread or price changes in the second half of the year.

“Looking ahead to 2026, we might see more movement, especially with the anticipated weakening of the dollar, which is one of the goals of the US government. There could also be volatility tied to the transition of the Fed’s leadership and changes in policy. And of course, the ongoing geopolitical situation adds another layer of uncertainty. So, while we don’t expect significant changes in the short term, medium-term volatility and potential spread widening are more likely as we approach 2026.”

In terms of regulatory updates to keep an eye on, Basel III, and the anticipated changes in risk-weighted asset (RWA) requirements, reducing CLO triple-A RWAs from 20% to 15%, could provide support for US banks to invest in CLOs.

“There’s the continued monitoring of US insurer capital treatment under the NAIC, potential reductions in capital requirements for banks, and the impact of evolving European risk retention rules, which have hindered some US market resets,” says Mehta.