CLO Equity Fund Market 2026 Update: Clearing Skies

Market Backdrop

The global CLO market entered 2026 on record momentum from 2025, which itself saw the second-highest annual broadly syndicated loan (“BSL”) CLO issuance total ever recorded. U.S. CLO issuance (combining BSL and middle-market CLOs) came in at approximately US$103.3 billion across 236 deals in Q1 before rising to US$126.5 billion across 285 deals in Q2, putting the first half of the year at close to US$230 billion. European issuance has been relatively steady with EUR30 billion in Q1 and EUR29.1 billion in Q2. The skies are clearing, but slowly, and anyone who has raised a CLO equity fund in the last eighteen months knows better than to leave the umbrella at home. After a stretch in which tight arbitrage and thin economics made new CLO equity fund raises difficult, the market appears to be reopening, if ever so slightly. April 2026 closings by Bain Capital, which raised approximately US$1.5 billion for its third captive equity fund, and CVC Credit, which raised US$1 billion for its fourth vehicle, a 25% increase over its predecessor, are early proof points that the sun is doing more than just peeking through. We expect the use of dedicated CLO equity funds, both captive and third party, to grow as a structuring and capital raising technology for the balance of 2026. Dechert has been involved in more CLO equity fund raises than any other law firm, representing over 25 platforms, including multiple funds raised by each. This OnPoint distills what we are seeing across that dealflow in 2026, with a primary focus on captive CLO equity funds, which have been evolving rapidly and are the vehicle driving most of the market's current structuring innovation.

From the Margins to the Mainstream

The CLO management business is, at its core, a high equity burn business. Even apart from risk retention rules, most managers need, as a purely commercial matter, to hold a substantial share of their own CLOs' equity to get deals done. Debt and equity investors alike generally want to see that a manager has equity in reserve for several more deals before they invest.

The earliest CLO equity funds trace their roots to the 2008 financial crisis and the risk retention rules Congress put in place to address the perceived abuses caused by the use of third party capital. As is the case with many well intentioned regulations, the U.S. risk retention rules had the unintended effect of pushing CLO managers to focus intensely on how to raise capital in compliance with the new regime. Even after the LSTA decision¹ made risk retention inapplicable to broadly syndicated CLOs, asset managers kept using the technology developed under that regime, deploying CLO equity funds as a means of providing stable execution capacity when new issue arbitrage is tight and third party appetite is selective.

Several factors also make CLO equity funds highly attractive for institutional investors:

• Scale and diversification. A single CLO equity fund delivers meaningful scale and broad obligor diversification across multiple CLOs in one commitment, an outcome no single direct CLO investment can replicate. This scale is particularly valuable for large institutional investors, such as pension funds, whose minimum investment size parameters often run well above what a single CLO equity tranche can absorb; a fund lets that capital be deployed efficiently across a diversified pool. It also reduces the counterparty diligence burden, since investors need only underwrite the fund manager rather than negotiate and diligence terms with each individual CLO manager whose equity they might otherwise seek to access directly.
• Preferred access to a preferred manager. For investors seeking exposure to a specific manager's platform, CLO equity funds offer a direct route to that manager's equity, often on preferred terms unavailable through any other channel. Many top tier managers reserve the bulk of their CLO equity for themselves or for anchor LPs in their platform, meaning an institution seeking direct, deal by deal access to a particular manager's paper may find the door closed, or open only a crack. By committing capital through the fund vehicle, an investor secures a standing, programmatic relationship with the manager across successive vintages, rather than renegotiating access, terms, and allocation on a one off basis for each new CLO.
• Superior current income. CLO equity should generally generate high cash yields through quarterly distributions, delivering current income that private equity style vehicles, which distribute value mainly at exit, simply cannot match. This distribution profile is especially attractive to institutional investors, such as insurers and pension funds, that face their own liability driven cash flow needs and prize predictable, recurring income over a multi year hold with a single liquidity event at the end. The quarterly cadence also gives investors an early, ongoing read on portfolio performance, rather than waiting years to learn whether an investment thesis played out.
• A compelling credit diversifier. Pension funds, sovereign wealth funds, family offices, endowments, and insurers are increasingly turning to CLO equity funds as a differentiated source of credit diversification within their broader portfolios. Because CLO equity returns are driven by loan level credit performance and active portfolio management, rather than by the same macroeconomic and interest rate factors that drive most fixed income and public equity allocations, adding CLO equity exposure can lower overall portfolio correlation.

Captive and Third Party CLO Equity Funds

There are two primary CLO equity fund types, each with distinct structural and strategic characteristics, though this categorization is directional rather than exhaustive: structures vary considerably within each type. Because we sit across a broad cross section of current fund formations of both types, we see terms early and repeatedly, well before they become market standard. Counsel whose practice is limited to general fund work at a single platform is prone to missing terms that a sophisticated investor will expect based on its other holdings.

Captive CLO Equity Funds. A captive CLO equity fund is managed by the same entity that manages the underlying CLOs and invests exclusively, or primarily, in the equity tranches of the manager's own CLOs. This provides the manager with a dedicated, reliable source of capital to anchor new deal issuance even when third party equity is on the sidelines. Captive funds typically hold majority equity positions, can be structured to facilitate EU and UK risk retention compliance by the underlying CLOs, and give the manager the ability to direct calls, resets, and refinancings, central to optimizing long term returns.

The private equity style drawdown fund is the predominant structure for captive CLO equity funds, drawing down capital as opportunities arise, with investors participating pro rata based on LP commitments. In our experience, CLO equity funds generate significant income during the fundraising process, which complicates equalization and makes the traditional private equity “cost plus” provisions difficult to apply cleanly. Withdrawals in these funds are generally not permitted; the fund expects to hold the CLO equity until early redemption or maturity. Current income, quarterly or semi annual, is distributed or reinvested during the commitment period depending on the fund's policy, and the ability to deploy capital relating to existing CLOs after the investment period is typically broad. Even within this common framework, individual terms, including drawdown mechanics, equalization, distribution policy, and termination rights, are routinely customized to match precedent that specific investors have negotiated elsewhere. That is why these documents rarely lend themselves to a template approach, and why experience across a wide range of them matters.

A structural feature common to captive CLO equity funds is a "series" management company, typically a Delaware series limited liability company or series limited partnership, sitting between the fund and the CLOs. Rather than the fund investing directly in each CLO's equity, the fund invests in more than one "series" of a single management company entity. This structure is commonly organized around three functional categories of series: (i) a management series, in which the collateral management of the CLO occurs and which receives the management fee income and manager side economics; (ii) one or more origination series, which enter into any forward sale arrangements and own any assets that default within the applicable risk retention seasoning period; and (iii) one or more investment series, through which fund investors hold their economic interest in the underlying CLO equity. While a single juridical entity, each series maintains segregated assets, liabilities, and records, and the debts and obligations of one series are generally not enforceable, as a contractual matter, against the assets of another series or of the management company generally.

Captive CLO equity funds typically charge only a single layer of fees, generally at the CLO level, with no management fee at the fund level other than in connection with investments in third party CLOs or similar investments. Combined with fee sharing arrangements that redirect a portion of CLO management fees to fund investors, this single fee structure can enhance effective returns relative to third party structures with dual fee layers.

One trend we are tracking closely is investor demand for tranching of LP interests and, relatedly, for getting a portion of the fund rated. Call it fair weather structuring: these requests seem to ebb and flow with the tightness of the arbitrage at the CLO level, and our cross platform vantage point lets us flag the shift as soon as it starts.

Third Party CLO Equity Funds. Third party CLO equity funds, sometimes described as "multi manager CLO equity fund" vehicles, have emerged as a distinct structural approach within the CLO market. Rather than investing in CLOs managed by an affiliated collateral manager, these funds allocate capital to the equity or junior debt tranches of CLOs managed by multiple, unaffiliated third party collateral managers. Several funds we have structured are built around investing in the debt and equity tranches of third party managed CLOs and are set up as interval funds: registered closed end funds that continuously offer new shares at net asset value but provide liquidity only through quarterly repurchase offers. We have also structured private hybrid funds combining both private equity fund features (e.g. drawdowns, close-ended) and hedge fund features (manager compensation arrangements) pursuing this strategy. These funds are run by managers who apply a systematic due diligence process before allocating capital across CLO managers. The appeal of the structure is manager diversification: rather than depending on the underwriting discipline and structuring choices of a single collateral manager, investors gain exposure to the collective judgment of several managers selected and monitored by the fund's own investment team, in exchange for accepting a liquidity profile closer to a private fund than a traditional listed vehicle.

The fund manager's role in a multi-manager structure is therefore one of curation rather than direct CLO management. One CLO ETF we structured illustrates this discipline on the debt side: the fund's portfolio managers source investments in the primary and secondary markets and apply a bottom up review of each CLO's cash flow waterfall, structural terms, and collateral performance, while the fund is expressly limited to investing no more than 20% of its total assets in CLOs managed by any single CLO manager. Unlike the interval funds discussed above, it is structured as an exchange-traded fund listed on NYSE Arca, with shares bought and sold continuously on the exchange at market prices that may differ from NAV. In each case, the fund manager is positioned to identify and select what it views as the strongest opportunities across the universe of third party managed CLOs, giving the fund's investors broader manager diversification than a single manager or proprietary CLO equity strategy would offer, while placing a premium on the sponsor's own manager selection and due diligence capabilities.

This manager diversification approach also shapes how these funds describe and manage risk to investors. Because a multi manager fund's performance depends on the collective skill of several outside managers rather than a single in house team, fund sponsors typically disclose "CLO manager risk" as a distinct risk factor, noting that they depend on the skill and expertise of third party collateral managers who are responsible for selecting, managing, and replacing the underlying bank loans, and that there is no guarantee any given manager will continue to manage a CLO through the life of the investment. For investors and their counsel, this framing is a useful marker of the multi manager category: rather than concentrating diligence on a single sponsor's underwriting record, it shifts attention to the sponsor's manager selection process, ongoing monitoring capabilities, the diversification limits, such as single manager concentration caps, built into the fund's investment guidelines, and the specific access structure through which that manager diversified exposure is delivered.

Legal Considerations for Captive CLO Equity Funds

Several key legal considerations relevant to captive CLO equity funds will need to be addressed in connection with these funds. A handful are discussed below.

EU and UK Risk Retention considerations. For captive CLO equity funds in particular, EU Securitisation Regulation compliance has become a meaningful competitive differentiator, both in fundraising and in underlying CLO execution. Captive CLO equity funds that serve as the CLO's risk retention entity, as is typical in captive structures, must comply with the EU Securitisation Regulation ("EU SECR") and the UK Securitisation Regulation.

Two developments over the past year have reshaped how managers structure retention vehicles. First, the European Supervisory Authorities clarified that the “sole purpose test" requires at least 50% of a CLO equity fund retainer’s revenue to come from sources other than risk retention holdings, accelerating the shift toward manager originator structures. We no longer see our clients setting up originator only structures. Second, the European Banking Authority confirmed that conditional sale agreements, once widely used to qualify as an originator, no longer satisfy EU SECR. The market has largely moved to forward purchase agreements, though whether these trigger U.S. risk retention under Regulation RR requires careful analysis.

The “series” management structure is useful in two related respects. First, for EU Securitisation Regulation purposes, it has a broad business purpose that includes management of a number of CLOs, together with the operational substance needed to support that broad business purpose. Second, the series structure lets a manager accommodate repeat CLO issuance by adding a new series under the existing management company each time it launches a new fund vintage, rather than forming an entirely new standalone entity for every deal.

Tax considerations. Tax structuring for CLO equity funds should take into account that, driven by rating agency criteria and market expectations, CLOs are typically structured and operated to accommodate a broad investor base, including U.S. taxable investors, non-U.S. investors, and U.S. tax-exempt investors. Accordingly, other than CLO ETFs and other registered funds, CLO equity funds are ordinarily structured as partnerships for U.S. federal income tax purposes in order to provide investors with pass-through tax treatment and, in general, to align investors’ tax consequences with those that would apply if they invested directly in the underlying CLOs. Depending on the composition of the investor base and commercial considerations, a CLO equity fund may be organized as a standalone vehicle or implemented through a master-feeder structure. The CLOs themselves are often structured as foreign corporations that are treated as “passive foreign investment companies” (PFICs) for U.S. tax purposes.

A careful and practical understanding of the PFIC regime — including the availability, mechanics, and consequences of elections — is therefore critical. Equally important is a detailed analysis of the tax profile of non-U.S. and U.S. tax-exempt investors, including the availability and limitations of applicable exemptions, withholding considerations, and issues such as effectively connected income (ECI) and unrelated business taxable income (UBTI).

ERISA Considerations. Sponsors of captive CLO equity funds also pay close attention to ERISA related considerations. Fund documents typically provide that the general partner will use reasonable efforts to limit participation by "benefit plan investors," within the meaning of Section 3(42) of ERISA, so that at all times less than 25% of the value of each class of equity interests in the fund is held directly or indirectly by benefit plan investors (calculated in accordance with the U.S. Department of Labor's plan asset regulation as modified by Section 3(42) of ERISA). Because of the potential for substantial undesired results of becoming “plan assets,” the general partner is typically given broad authority to take action to prevent it from occurring, including the right to require affected investors to transfer their interests to a third party or otherwise withdraw from the fund. Sponsors also generally require each prospective investor to make ERISA and Section 4975 of the tax Code (and related) representations at subscription—which are in effect for the life of the investment— and each investor is also directed to consult its own advisors on the application of ERISA, Section 4975 of the tax Code and related matters in connection with its investment.

The Road Ahead: Clearing Skies

The CLO equity fund market entered 2026 under arbitrage pressure but has shown clear signs of reopening since the second quarter. The forecast is improving, not clear, and managers who mistake a break in the clouds for a permanent front will be the first ones caught without a raincoat.

Several themes will shape the next phase. Distribution capability is becoming as important as track record. We have seen shelf space and distribution reach, not product performance alone, increasingly determine which managers capture flows. A related theme is execution capability once investor interest is identified: successful managers will have several levers to close deals with third party equity buyers in a difficult arbitrage environment. Scale and platform consolidation are also accelerating, evidenced by the size of the funds being raised. Together, these trends suggest that a manager's distribution network, its capacity to secure room in an increasingly crowded product pipeline, and its ability to bring the full range of structuring and pricing levers to bear once investor interest is identified may prove as decisive to a CLO equity fund's success as its investment strategy or manager selection discipline.

Sponsors bringing new funds to market are best served by counsel who see the full range of terms investors are asking for across the market, not counsel encountering a bespoke fund structure for the first time. In a market where the weather can turn in a single quarter, a forecaster who has only ever seen one season is not much use.

Dechert's Finance and Real Estate Group, Financial Services Group and Structured Finance Practice have represented managers, sponsors, equity investors, and lenders across the full spectrum of CLO equity fund structures and transactions, including new CLO equity fund formations, captive and third party fund structures, CFOs subscribing for interests in CLO equity funds, NAV facilities, hybrid facilities, asset based lending, EU and UK risk retention compliance, and CLO manager regulatory matters.

Footnote

1. Loan Syndications and Trading Association v. SEC, 882 F.3d 220 (D.C. Cir. 2018), was argued on October 10, 2017, and decided on February 9, 2018.