Key takeaways: Enhanced income and diversification potential: for investors seeking enhanced income and diversification potential, mezzanine and equity tranches can offer a complementary solution to traditional corporate credit or private credit allocations. Distinct portfolio roles: Mezzanine and equity tranches rank below senior investment grade tranches in the capital structure, and they offer different risk and return profiles. CLO manager selection is a key differentiator of outcomes: the dispersion of CLO equity returns has historically been wide, creating the opportunity for active managers to add value The structured nature of collateralized loan obligations (CLOs) means that they offer solutions that can meet a spectrum of investor objectives. Investment grade tranches are increasingly well understood as a cash enhancement, offering comparable or higher yields relative to equivalently (or lower) rated corporate bonds, but with the additional benefit of credit enhancement. For those investors seeking enhanced income, CLO equity and mezzanine tranches offer a differentiated proposition to both traditional and private credit. A key aspect of their appeal is the enhanced income and diversification potential. For mezzanine debt, this is in addition to the structural features providing protection that is unavailable from equivalently rated corporate credit. These features, and broader CLO mechanics, are discussed in more detail in our primer, Decoding CLOs: the mechanics, structure and investment case . There are a range of considerations including structure and liquidity, but as we discuss, CLO manager selection is especially important in a sub-asset class that has historically witnessed high dispersion in return outcomes. A recap on equity and mezzanine tranches Sitting at the bottom of the CLO capital structure, the equity tranches receive no contractual coupon income but instead receive the residual cash flows after the other tranches and management fees have been paid. In short, the equity tranche offers the greatest return potential, in exchange for the highest risk exposure. The mezzanine tranche sits between the senior investment grade tranches above, and equity below. It has a higher potential yield than the senior tranches, in exchange for less structural protection. A hypothetical CLO capital structure is illustrated below in figure 1. Figure 1: An illustration of where equity and mezzanine tranches sit in the CLO capital structure Source: RBC BlueBay Asset Management, August 2026. % capital structure shown as an illustration Why allocate to CLO equity and mezzanine debt? CLO equity offers an alternative credit risk exposure, with equity-like risk and return characteristics given high potential upside, but first-loss exposure. Meanwhile, CLO mezzanine debt has historically offered a spread premium relative to comparably rated corporate credit and structural protection. This reflects some selection and illiquidity premia that a specialist manager is well-placed to capture. Both equity and mezzanine tranches capture floating rate exposure. Mezzanine tranche income adjusts as benchmark rates (e.g. SOFR1, Euribor2) change. Meanwhile, equity is broadly shielded from interest rate duration by the fact that the assets (loans) and liabilities (securitized bonds) both adjust with rates. The floating rate nature is an important benefit versus traditional fixed income, and particularly so in volatile rate. What portfolio solutions do equity and mezzanine exposures offer? In broad terms, there are two key portfolio solutions that these tranches have potential to deliver: Income/return enhancement: for investors seeking higher yields or return enhancement, these tranches offer the potential to capture a combination of higher income via the mezzanine debt and higher returns from the equity. Portfolio diversification: for investors with traditional or alternative fixed income exposure, these tranches offer potential for diversification. Their floating rate profile can reduce interest rate duration risk whilst also generating a spread in excess of comparable corporate credit. The front-loaded nature of CLO equity cash flows means it can complement private credit allocations, where investments are more dependent on returns later in the investment lifecycle. What are the key drivers of returns for equity and mezzanine tranches? As well as sitting at different points in the capital structure, and hence risk spectrum, the return generation mechanisms of equity and mezzanine tranches are distinct. CLO equity represents a claim on residual cash flows, whilst mezzanine is a contractual credit spread premium. Common equity and mezzanine return drivers Credit performance of the underlying portfolio is fundamental, including credit rating migrations, covenant breaches, default rates and recovery value of any defaulted loans. Stronger credit performance typically means higher mezzanine and equity returns. Active CLO manager skill in constructing the initial portfolio, managing risk, and reinvesting principal payments during the reinvestment period (typically 3-5 years) is a significant driver of returns. The macroeconomic and technical backdrop is also important in terms of impact on liability spreads as well as the conditions for reinvestment and market technicals. Equity-specific return drivers Leverage – the CLO’s loan portfolio is primarily funded by senior debt (illustrated in figure 1), with equity as the residual slice. Equity holders therefore capture the spread earned on the overall portfolio, less the cost of funding, which is a structural source of enhanced returns. The CLO arbitrage – the differential between the credit spread generated on the underlying portfolio of leveraged loans, and the blended spread (the weighted average across the different tranches) paid to securitised credit investors – is the main driver for CLO equity. It determines the amount of ongoing income available to equity after debt obligations are paid. The loan market conditions at portfolio inception therefore have an important bearing on returns. Interest only/principal only decomposition – cash flows from CLO equity can be viewed as (i) an ongoing interest only income stream, which is driven by the arbitrage spread, and (ii) the residual value, or principal only, claim when the CLO is wound down. Refinancings – if market spreads for CLO debt fall, the manager can call the existing (fixed-spread) debt and reissue it lower (after an initial non-call period). Loan cash flows are unchanged, but the lower funding cost widens the arbitrage, benefiting equity holders. Resets – after the non-call period, a CLO can be reset – resetting the capital structure to prevailing market levels and extending the reinvestment period. This enables the manager to lock in current spreads and compound value for longer, rather than the deal amortizing. If a reset isn’t economic, equity can opt for redemption instead. The length of CLO reinvestment period – the longer the reinvestment period, the longer the time for managers’ trading gains to compound and deliver value. Liquidations – at any time after the non-call period (but typically after the end of the reinvestment period), equity holders have the option to redeem the CLO – selling the loan portfolio and distributing the proceeds after debt is repaid. This realises the portfolio’s value to equity and can crystallize accumulated gains. Mezzanine specific drivers The subordination cushion – the adequacy of this cushion is important as this acts as a buffer against any losses before they reach the mezzanine debt. Coverage tests – overcollateralization and interest coverage tests compare the portfolio’s value and income against debt obligations. If they fail, cash is diverted from equity to pay down senior debt, deleveraging the structure and protecting mezzanine debt tranches. The cushion above these thresholds is a key indicator of mezzanine bond health. Rating migration sensitivity – mezzanine tranches are the most exposed to rating transitions on the underlying loans, since they sit at the credit-sensitive part of the structure. Recovery rates – losses, as opposed to defaults, erode the subordination cushion. Low recovery rates shrink the buffer faster. This is the mechanism through which defaults impact mezzanine tranches and is often more decisive than the default rate alone. Why CLO manager selection is crucial CLO equity returns are more dependent on the performance of the active CLO manager, and their particular investment process and style. Indeed, the difference in performance between the top and bottom quartile CLO managers is wide, as figure 2 illustrates. The manager’s decisions, from initial portfolio construction and selection of different credits (industry, sector, market), to ongoing management through the evolving macro environment, can meaningfully impact outcomes. Figure 2: CLO equity/manager return dispersion by calendar year Past performance is not a reliable indicator of future results Source: Nomura, RBC BlueBay Asset Management, as at 30 July 2026. Note: Unlevered returns are defined as monthly market value return + carry, annualized and weighted by deal notional par; when calculating the carry, a static portfolio intra month is assumed, i.e. the monthly carry is based on the portfolio Weighted average spread at the beginning of each month; does not include market value of reorg equity; 2026 YTD returns as of 30 July 2026. What does historical performance look like? Over the longer term, going back to 2011, CLO equity tranches have offered mid-teen annualized distributions, illustrated in figure 3. This period saw an average annualized distribution of 13.4%, with 2012 the only calendar year in which distributions dipped below 10%. Figure 3: Calendar year CLO equity distribution rates have averaged in the mid-teens Past performance is not a reliable indicator of future results Source: Deutsche Bank, RBC BlueBay, as at 31 December 2025 More broadly, CLO performance has been very resilient, especially when compared with global corporate credit of an equivalent rating. Below, we show an example of this resilience through the 2008 global financial crisis (GFC). The GFC triggered significant drawdowns and volatility across financial markets. In a challenging macro environment, it is not a surprise to see a rise in credit defaults. The highest risk corporate credits, rated BB and below saw a default rate of almost 33%. And yet equivalent rated CLO tranches saw only 8% and 4% default rates in European and US CLOs, respectively. This data is shown in figure 4. Figure 4: CLO and corporate credit performance through the GFC Past performance is not a reliable indicator of future results Source: S&P, 31 December 2025 (CLO data) and Moody’s, as at July 2026 What are the risks? The precise nature of risks again varies between equity and mezzanine tranches. We discuss some of the key risks below: Credit risk in the underlying portfolio: If loans experience losses, cashflows are allocated by seniority, potentially wiping out equity tranches and impacting mezzanine debt in severe scenarios. Manager risk: this is a key risk for CLO equity, because it is dependent on CLO management, in terms of security selection decisions, for return generation. Reinvestment risk: if loan spreads tighten, this can pressure the CLO manager to reinvest on less attractive terms, in turn compressing the CLO arbitrage, and in turn cash flows to equity. This is less of a concern for mezzanine debt given its fixed spread. Illiquidity risk: in periods of market volatility secondary market liquidity can deteriorate, with bid-ask spreads widening materially, and forced sellers crystallising mark-to-market losses on fundamentally sound positions. This is most relevant for CLO equity. Beyond traditional bonds: a differentiated allocation The CLO market has witnessed strong growth over the past decade, and we expect this to continue amid a broadening investor base. This is regulatory driven in the insurance sector, whilst we are seeing a wider range of investors seeking enhanced returns and greater diversification within their fixed income allocations. For investors looking beyond traditional corporate credit, CLO equity and mezzanine tranches offer a compelling route to enhanced income and diversification. CLO Equity offers high return potential, with front-loaded distributions that can complement private credit allocations, in exchange for first-loss risk. Mezzanine tranches, meanwhile, provide a higher-yielding alternative to traditional corporate credit of a comparable credit rating. In both cases, the dispersion of outcomes across CLO managers is wide, making active selection a key driver of results.