ETF podcast ep 6: CLOs Explained: harnessing ETFs to access the opportunity

CLOs Explained: harnessing ETFs to access the opportunity

Welcome to our ETF podcast.

I'm Christine Huang, Head of ETF Business at the Invesco Asia Pacific. In our previous episode, we covered the fundamentals of bank loans and the CLOs (Collateralized Loans Obligations). Today we are joined by Derek Fin, Senior Client Portfolio Manager of the Invesco Private Credit Group. We'll have a deep dive into the CLO's market.
So hi, Derek.

Hey, Christine, thanks for having me.

Hi. We all are aware that recently CLOs has gained significant attention from the market. So can you share this a bit more on the CLO market size and what’s the biggest drivers of CLO market?

Yeah, it's a great question and a very exciting time to be talking about the CLO market. I think the interest and demand for the asset class has really shown in the growth of its size.

So if you look at the global CLO market today, it's 1.4 trillion in size, that's about 1 trillion in the US CLO market and 400 billion in the European CLO market. (Source: Bloomberg, April 2025)

And a lot of that has been driven by the growth of the underlying assets of CLOs, broadly syndicated loans or senior loans that have grown to almost 2 trillion in size globally and now bigger than actually the high yield bond market from just a couple years ago. (Source: S&P UBS as of March 31, 2025)

Wow, that's amazing growing market of CLOs.

So why are investors interested in CLOs in the current market environment?

Yeah, it’s a great question because there's really a lot of ways to answer that. There's a lot of unique aspects that CLOs offered that other traditional fixed income asset classes don't, right?

For as, starters, it's a floating rate asset class, right. So as rates rose higher, your, your coupon, and your yield for CLOs also increased with those rising rates.

CLOs historically have been one of the most defensive asset classes. As we know, not all investment grade asset classes are created equally. Unfortunately, we learned that the hard way during the financial crisis. But CLOs have been one of the strongest performing asset class with no defaults historically even during the financial crisis.

So when we look at the history of the CLO performance back to global financial crisis. So how did CLO notes perform at that time?

Yeah, it's a good point because a common misconception unfortunately for our asset class is we fall under AAC acronym. So CDOs (Collateralized Debt Obligation), CLOs, a lot of people are concerned about CDOs because of the really negative performance that you saw during the financial crisis.

So even though the C in the CLOs also stands for collateralized, the next two letters in that acronym are very different loan obligations, right. So I mentioned before the underlying assets for a CLO are senior secured loans.

So these are more defensive, more diversified underlying assets compared to something like CDO's where a lot of that higher default rate, higher credit loss into the, call it 40 to 50% credit loss range was exposure to the housing market, right. (Source: Harvard Kennedy School, March 2009.

That's very different from the CLO market. That's really diversified exposure to over 24 different sectors. You're senior secured to the underlying assets, all the underlying assets of these companies.

You didn't have a single default for AAA CLOs down to AA's and even a single A CLO, I think it was just one default. (Source: Moody’s, Morgan Stanley Research, Data from 1993-2023. Past performance does not predict future returns.) So it's proven the defensiveness throughout even a severe downside scenario like we saw during the financial crisis.

What would you summarize in terms of the features of an AAA CLO?

Yeah, I think I touched on a few of those and maybe just to hit on some of the key points.
One is this is an AAA investment grade asset class, but the most defensive AAA asset class. You can't say for most other AAA's that you've never had a default even during the financial crisis. (Source: Moody’s, Morgan Stanley Research, Data from 1993-2023. Past performance does not predict future returns.)

The second component to that is the higher spread pick up or the higher yield that you're getting in CLOs. So by adding AAA CLOs, you're diversifying your portfolio, you're reducing your risk from a credit loss perspective.

So we really do think it, it's one of the asset classes that are relatively new, but definitely under allocated for a lot of not just retail clients, but also some of our more sophisticated institutional clients.

How did AAA CLOs notes perform during the global financial crisis?

It's a really great question because we, we get it often in comparing relative to another acronym CDOs (Collateralized Debt Obligations), which unfortunately because we have the same starting letter in that acronym that C collateralized, we get bucketed in an asset class such as CDOs that did not perform well historically.

So if you look at the historical track record back during the global financial crisis, something like CDOs had credit losses between call it that 20 to 30 even 40% range. (Source: Harvard Kennedy School, March 2009.)

You compare that to AAA CLO notes. Historically you haven't had a single default for AAA CLOs, AA CLOs, and even for a single A CLO that you saw one default historically during the financial crisis.

So it's really proven it's the structure works, and even in a severe downside scenario like you saw during the financial crisis, CLOs have performed much better than similarly rated asset classes.

So Derek, for the AAA CLO notes, can you share us more in terms of what the key features for this tranche of CLO?

Yeah, I think one of the main reasons why a lot of clients are looking into this asset class today is, again looking back on that historical performance, right.

So if you look historically, AAA CLO notes are one of the best performing asset classes, right.

I mentioned before during the financial crisis never had a default and you compare that to other AAA fixed income asset classes, those default ranges historically have been much higher. (Source： Moody’s, Morgan Stanley Research, Data from 1993-2023. Past performance does not predict future returns.)

The second component is because of the complexity premium or the liquidity premium of this asset class in CLOs, you've historically had a higher spread pick up relative to similarly rated AAA or double A CLOs .

So not only are you getting more downside protection through that historically no default rate environment but also going forward you have that higher spread pick up that you get relative to other fixed income asset classes.

So what would you explain to us in terms of rules using CLOs into a portfolio asset allocation?

Yeah, I think that's a great point because there's really two ways, we think about it when we talk to our clients.

There's that core strategic asset allocation where if you look historically adding AAA CLO notes to any multi asset portfolio because of the diversifying benefits not only increases your spread and yield potential but also reduces your volatility because it's a floating rate asset.

So you think about the past 10 years, you weren't exposed to that interest rate volatility.

And the second component more tactically, if you think about the environment that we're in today, that rising interest rate environment, that higher for longer interest rate environment that's beneficial for a floating rate asset class like AAA CLO notes where you're seeing some of the highest starting yields that you've seen over the past decade and again,  AAA rated asset class.

So we really do think that clients are going to continue to increase their exposure to CLOs.

Just to give you some real time color, I was in Tokyo and we met with a lot of Japanese investors. We had 18 meetings with our CLO team in the US and 14 meetings with our European CLO team. And every client conversation that we had, they were looking to increase or at least maintain their allocation to AAA CLOs.

Thanks Derek for sharing all the insights on the CLO market.

CLO is a rapidly growing asset class that could be an attractive complement to an income portfolio. Triple A CLO notes offer one of the highest yields in the investment grade rated credit, using ETF can provide a full transparency, lower cost and adding additional liquidity for investors seeking CLOs exposure. (Source: Invesco, The Case for AAA-rated CLO notes, January 2025)

Thanks for spending time with us.

See you all next time.