A CLOser LOOK AT CLOs

In a year where heightened rate volatility continues to dominate headlines, income remains a key theme driving fixed income returns. This has led to investors staying on the sidelines with cash, with over USD 7 trillion sitting in money market funds¹. Within fixed income, short duration exposures have been favored - short duration US Treasuries account for over 80% of iShares US Treasury ETF inflows year to date². At the same time, demand for CLO ETFs has been robust with over USD 11B inflows this year², buoyed by attractive all-in yields and a benign credit backdrop, even as markets adjust to a “higher for longer” rate regime. For investors looking to step out of cash while enhancing returns, AAA CLOs present a compelling opportunity for uncorrelated income opportunities while maintaining a low risk profile.

Today, the CLO market exceeds USD $1.2T in size globally – comparable to the US high yield bond market. Although CLO ETFs are relatively new, they have experienced rapid growth, with AUM reaching USD 33B today, more than double what they were just a year ago.³ The ETF wrapper is proving transformative, unlocking liquid access to an asset class that has been traditionally niche to the broader investor base.

Figure 1: AAA CLO returns driven by stable income over time³

A CLO is an investment vehicle that owns primarily high yield floating rate loans and issues tranches through the process of securitization. Subordination of cash flows across tranches means that each tranche offers different levels of exposure to credit events in the underlying pool of loans, hence varying in credit risk and ratings.

Through this process of credit enhancement, the senior AAA tranche is the lowest in credit risk, designed to be the last to absorb potential losses.

No AAA CLO has ever defaulted in the history of the asset class, weathering the Global Financial Crisis and Covid pandemic with minimal losses.⁴

Figure 2: Subordination of cash flows provides the highest degree of protection for AAA CLOs

AAA CLOs currently offer 5.6% yield with a duration of just 0.2 years, an attractive pickup over cash rates at 4.2%, while boosting portfolio credit quality. Higher yielding than similarly rated corporate debt, the floating rate nature of CLOs also provides insulation against interest rate risk. AAA CLOs have demonstrated resilience in market stress – during Liberation Day, AAA CLOs saw a drawdown of just -0.41% against a -1.91% drawdown in USD IG credit⁵, reinforcing the lower volatility of the asset class and its appeal as a step out of cash solution.