Investing in AAA-rated CLOs through ETFs: An explainer

What are CLOs?

Collateralized Loan Obligations, or CLOs, are securitized vehicles backed primarily by senior secured leveraged loans, which are floating-rate instruments typically used in M&A and private equity buyouts, and by both private and public companies for various reasons.

These loans, rated below investment grade, are syndicated by banks and actively traded in secondary markets. A CLO pools loans from hundreds of unique borrowers and distributes interest and principal payments through a structured waterfall to various tranches, with the highest-rated AAA tranches sitting at the top of the capital structure.

How large is the CLO market?

The CLO market has grown into a US$1.4 trillion² segment of fixed income, nearly doubling in size over the past five years. Despite its scale, CLOs remain one of the least understood asset classes in fixed income, largely due to its private credit nature and historical inaccessibility to most investors. Until recently, only the largest institutional investors could participate in this market, particularly in the highest-rated AAA tranches.

That changed with the launch of ETFs focused on AAA-rated CLO notes. The first such ETFs were introduced in the US about five years ago. Since then, these ETFs have gained traction globally. Today, actively managed AAA-rated CLO ETFs see over US$44 billion in assets³, reflecting growing demand from a broader investor base seeking yield, credit quality, and diversification.

Why are AAA-rated CLOs attracting investor interest?

We believe AAA CLOs are particularly attractive because they can offer high credit quality, floating-rate exposure, and historically low default rates. However, their complexity and limited liquidity have made them difficult to access for most investors, until ETFs entered this space.

Until very recently, CLOs were only easily accessible to the largest institutional investors. Although new CLO deals come to market regularly, historically the AAA tranches would have been bought in the primary market by a few large institutions while smaller investors would not have been able to access much of the market. ETFs have provided an access point to this asset class for a much wider range of investors. But it’s not just the access point that they provide; the ETF structure is particularly beneficial for certain fixed income segments like AAA-rated CLOs, which may not be as liquid as traditional public fixed income markets.

What are the potential benefits of using an ETF for AAA-rated CLO exposure?

AAA-rated CLO ETFs can offer several potential benefits: diversified exposure to many CLOs and underlying borrowers; cost efficiency through economies of scale and typically lower fees; liquidity as the secondary market allows investors to trade ETF shares without directly transacting in the underlying securities; and transparency and flexibility as ETFs provide real-time pricing and can be used for both strategic and tactical asset allocation.

These benefits are particularly valuable in less liquid markets like CLOs. While the CLO market is large, its private credit nature means individual securities may not trade frequently. ETFs mitigate this challenge by offering exposure via a liquid secondary market, where investors can buy or sell shares without triggering transactions in the underlying CLO notes.

This mechanism allows market makers to manage inventory and risk efficiently, often resulting in tighter bid-offer spreads than the underlying securities themselves. For many investors, this means they can swiftly adjust exposures to the CLO asset class, especially during periods of market dislocation, without needing granular issuer-level knowledge. Not only could they adjust their allocation almost immediately after the decision-making process, but they would gain diversified exposure to that asset class in a single trade.

What’s the case for active management in AAA-rated CLO ETFs?

While passive ETFs offer broad exposure, active management adds an important layer of value in the CLO space. CLOs are complex instruments with varying structures, collateral quality, and manager performance. Using an experienced specialized active manager can help:

Select top tier CLO managers and deals: Not all AAA CLO tranches are created equal, and issuer due diligence is critical. Active managers can assess deal structure, collateral composition, and manager track record to carefully identify opportunities.

Manage risk effectively: CLOs are sensitive to changes in credit markets, interest rates, and macroeconomic conditions. Active managers can adjust positioning in response to evolving risks.

Optimize liquidity and execution: In less liquid markets, trading efficiency matters. Active managers can navigate bid-offer spreads and manage portfolio turnover to minimize costs.

Capture relative value: CLO pricing can diverge from fundamentals, especially during periods of volatility. Active managers can exploit these inefficiencies to enhance returns.

In short, active management allows investors to benefit not just from access and efficiency, but also from specialized decision making and risk management.

What is the key takeaway for APAC investors?

For APAC investors, AAA-rated CLOs offer a compelling combination of yield, credit quality, and floating-rate exposure. Historically reserved for large institutions, these vehicles are now accessible to a wider range of investors through ETFs. The ETF structure provides liquidity, transparency, and efficiency, making it an ideal vehicle for accessing this complex asset class.

Active management within the ETF wrapper is particularly important for APAC investors. By combining the structural advantages of ETFs with the expertise of active managers, APAC investors can gain efficient and targeted exposure to AAA-rated CLOs. As the CLO market continues to evolve, we believe actively managed ETFs are poised to play a central role in how investors access and allocate to this growing asset class.

Investment risks

For complete information on risks, refer to the legal documents.

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

The creditworthiness of the debt the Fund is exposed to may weaken and result in fluctuations in the value of the Fund. There is no guarantee the issuers of debt will repay the interest and capital on the redemption date. The risk is higher when the Fund is exposed to high yield debt securities.

Changes in interest rates will result in fluctuations in the value of the Fund.

It may be difficult for the Fund to buy or sell certain instruments in stressed market conditions. Consequently, the price obtained when selling such instruments may be lower than under normal market conditions.

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.