The Case for CLOs: Why These ETFs Belong in a Modern Portfolio

In today’s challenging market landscape, investors face a conundrum: how to generate yield without taking on excessive risk. Bonds are no longer the unchallenged safe haven they once were, and equity markets remain volatile amid uncertain macroeconomic trends. Against this backdrop, collateralized loan obligations (CLOs) — and the ETFs that track them — are increasingly gaining traction as a strategic solution for modern portfolios.

What Are CLOs?

Collateralized loan obligations are structured credit products backed by a diversified pool of senior secured loans, typically made to businesses with below-investment-grade credit ratings. These loans are bundled together and sold in tranches, each with varying degrees of risk and return. The senior tranches get paid first and offer lower yields, while junior tranches carry higher yields to compensate for greater risk.

CLOs are not new. They've been around since the 1990s and weathered the global financial crisis better than many other structured products. Their performance and resilience are largely due to the fact that CLOs are actively managed and diversified across sectors and issuers, reducing exposure to any one borrower.

Why CLO ETFs Are Gaining Popularity

Until recently, direct investment in CLOs was reserved for institutional investors due to the complexity, size, and minimum capital requirements. But the emergence of exchange-traded funds focused on CLOs has changed the game, offering retail and smaller institutional investors efficient, low-cost access to this once-exclusive market.

Here’s why CLO ETFs are becoming a staple in forward-looking portfolios:

1. Attractive Yields in a Low-Return World

CLOs typically offer higher yields than similarly rated corporate bonds. This premium compensates investors for the illiquidity and complexity of the asset class. In a time when Treasury and investment-grade corporate bond yields are still historically low, CLO ETFs provide a compelling alternative for income-focused investors.

2. Floating Rate Exposure as an Inflation Hedge

Most CLOs are backed by floating-rate loans, which means their interest payments rise with benchmark rates. In a rising interest rate environment — or even in an environment where inflation risk is elevated — CLOs can provide a natural hedge against rate volatility. CLO ETFs allow investors to tap into this dynamic without directly managing individual loans or tranches.

3. Credit Quality and Diversification

Despite being backed by below-investment-grade loans, the senior tranches of CLOs have historically demonstrated strong credit performance, even during periods of economic stress. CLO managers actively monitor and rebalance portfolios, which helps mitigate credit deterioration. CLO ETFs provide broad diversification across managers, sectors, and maturities, helping to spread risk more effectively than single-issuer corporate bonds.

4. Liquidity and Transparency

CLO ETFs trade on major exchanges like any other ETF, offering daily liquidity and price transparency. While underlying CLOs may be relatively illiquid, the ETF structure allows investors to enter and exit positions without negotiating directly in the opaque OTC loan market.

Examples of CLO ETFs to Watch

Several issuers have launched CLO-focused ETFs, each with its own unique structure and exposure profile. A few examples include:

• VanEck CLO ETF (CLOI) – Offers investment-grade-rated CLO tranche exposure with active management.

• Janus Henderson AAA CLO ETF (JAAA) – Targets the most senior, AAA-rated CLO tranches, focusing on capital preservation with attractive yields.

• BlackRock AAA CLO ETF (CLOA) – Provides diversified exposure to senior CLO tranches, aiming for enhanced yield with low credit risk.

Each of these ETFs provides varying levels of risk, return, and duration profiles, allowing investors to tailor their fixed income allocations more precisely.

Considerations and Risks

While CLO ETFs offer compelling advantages, investors should also understand the risks:

• Complexity: CLOs are structured instruments with multiple tranches and embedded leverage. Not all ETFs are created equal — diligence is needed.

• Credit Risk: Although senior tranches are historically stable, economic downturns can still lead to downgrades or losses in the underlying loans.

• Liquidity Risk: While ETFs themselves are liquid, the underlying assets may not be. In times of market stress, ETF spreads may widen.

Final Thoughts

CLO ETFs provide a unique blend of income, diversification, and inflation protection — attributes that are increasingly valuable in today's investment climate. For investors seeking to modernize their fixed income allocations without venturing too far into high-yield or speculative debt, CLO ETFs represent a compelling middle ground.

Incorporating CLO ETFs into a portfolio isn’t just a yield grab — it’s a strategic move toward building a more resilient, well-rounded investment strategy. As awareness grows and offerings mature, CLOs may no longer be the hidden gems of institutional portfolios — they may become mainstream tools in the modern investor’s toolkit.