CLO FAQ: Frequently Asked Questions
General Questions
What is a CLO in simple terms?
A CLO is an investment vehicle that buys 150-300 corporate loans and issues bonds backed by those loans. It's like a mutual fund for loans, but with a specific structure: senior investors (AAA-rated bonds) get paid first and have the safest position, while junior investors (equity) get paid last but earn higher returns.
Are CLOs safe?
AAA-rated CLO tranches have never defaulted in 30+ years (1994-2025). However, "safe" does not mean "risk-free." AAA CLOs face:
- Mark-to-market volatility (prices can drop 10-15% during market stress)
- Liquidity risk (difficult to sell quickly at fair prices)
- Refinancing risk (may be called early, forcing reinvestment at lower yields)
Mezzanine tranches (BBB/BB) can experience payment deferrals. Equity can lose 30-100% of capital during severe downturns.
Learn more about CLO structure →
Are CLOs the same as the toxic CDOs from 2008?
No. This is the most common and damaging misconception. Key differences:
- CLOs: Senior secured corporate loans (70-80% recovery rates)
- CDOs: Subprime mortgages (20-40% recovery rates in 2008)
- CLO AAA defaults: Zero (ever)
- CDO AAA defaults: Widespread in 2007-2009
- CLO management: Active trading by professional credit managers
- CDO management: Often static, passive pools
Read the full CLO vs CDO analysis →
How big is the CLO market?
$1.2 trillion globally ($950 billion in the U.S. as of Q4 2024). This makes CLOs one of the largest fixed income asset classes, comparable in size to the high-yield bond market.
Investing Questions
What is the minimum investment for CLOs?
- Direct CLO tranches: $1-2 million (institutional investors only)
- CLO ETFs (JAAA, CLOI, CLOZ): Cost of 1 share (~$25-50)
- CLO equity funds: $250K-$1M+ (accredited investors)
For most retail investors, CLO ETFs are the only practical access point.
What are typical CLO returns?
- AAA debt: SOFR + 120-150 bps (6-6.5% all-in when SOFR = 5%)
- BBB debt: SOFR + 285-350 bps (7.9-8.5% all-in)
- BB debt: SOFR + 500-600 bps (10-11% all-in)
- Equity: 12-18% gross IRR (highly variable by vintage and manager)
View comprehensive historical return data →
Can I lose money in AAA CLOs?
Yes, in several ways:
- Mark-to-market loss: If you sell during a downturn (e.g., March 2020), prices may be 85-92 cents even though no defaults occurred
- Spread widening: If CLO spreads widen from 130 to 200 bps, existing AAA bonds decline in value
- Opportunity cost: If reinvesting at lower yields after refinancing
However: No AAA investor has ever lost money due to defaults (principal non-payment). All AAA losses have been market-pricing related, not credit events.
Should I invest in CLO ETFs or direct CLO tranches?
| Factor | CLO ETFs | Direct CLO Tranches |
|---|---|---|
| Minimum | $25-50 (1 share) | $1-2 million |
| Liquidity | Daily (exchange-traded) | Limited (OTC secondary market) |
| Diversification | 50-150 tranches per ETF | Single tranche |
| Fees | 0.27-0.50% annually | No ongoing fees |
| Best For | Retail investors, smaller allocations | Institutions, $10M+ allocations |
For 99% of investors, CLO ETFs are the better choice.
Risk Questions
What happens to CLOs in a recession?
Historical evidence from 2008-2009 and 2020:
- AAA tranches: Continued receiving 100% of scheduled payments. No defaults.
- AA/A tranches: Minimal impact. A few downgrades but no widespread defaults.
- BBB tranches: Some experienced interest payment deferrals (cash diverted to AAA). Most eventually paid accrued interest.
- BB tranches: Many experienced deferrals; some principal losses in 2007-2008 vintages.
- Equity: 2007-2008 vintages saw 30-60% capital losses. 2020 vintages experienced temporary NAV declines but recovered.
View historical default rate data →
What if interest rates fall? Do CLOs lose value?
CLOs are floating-rate securities that reset quarterly based on SOFR. If SOFR falls:
- Coupon income declines: A CLO yielding SOFR + 140 bps will earn less absolute income if SOFR drops from 5% to 3%
- Spread (140 bps) remains constant: Unless credit conditions worsen
- Price impact: Minimal duration risk compared to fixed-rate bonds
Key advantage: If rates rise, CLO coupons rise, unlike fixed-rate bonds which lose value.
Learn more about interest rate risk →
Can CLO managers steal or misuse funds?
No. CLO structures have multiple protections:
- Bankruptcy-remote SPV: Loans are held in a special purpose vehicle legally separated from the manager
- Trustee oversight: Independent trustees monitor compliance and distribute cash flows
- Monthly reporting: All holdings and transactions disclosed monthly
- Trading limits: Indentures restrict manager discretion (e.g., must maintain diversity, can't exceed concentration limits)
Tax Questions
How are CLO ETFs taxed?
- Ordinary income: Most distributions are taxed as ordinary income (not qualified dividends)
- Tax inefficiency: Not suitable for taxable accounts if you're in high tax brackets
- Best practice: Hold CLO ETFs in IRAs, 401(k)s, or other tax-advantaged accounts
Do CLO equity investors receive K-1s?
Yes, for direct CLO equity investments. K-1s can be complex with multiple income categories. This is another reason retail investors prefer ETFs (which issue simple 1099 forms).
Structure and Mechanics
What are coverage tests and why do they matter?
Coverage tests (OC/IC) are automatic triggers that redirect cash flows from junior tranches to senior tranches when portfolio quality deteriorates.
- Overcollateralization (OC) test: Assets must exceed liabilities by a specified percentage
- Interest Coverage (IC) test: Interest income must exceed interest expense by a specified percentage
Why they matter: These tests are the primary reason AAA CLOs have never defaulted. When defaults rise, tests fail, and cash automatically flows to protect AAA investors.
What is CLO equity and why is it so risky?
CLO equity is the first-loss position at the bottom of the capital structure:
- No fixed coupon: Receives residual cash flows after all debt is paid
- First to absorb losses: 100% of defaults reduce equity value before any debt is impaired
- Target returns: 12-18% IRR, but highly variable (2007 vintage: 6%, 2010 vintage: 18%)
- Minimum investment: Typically $5-25 million (institutions only)
How long do CLOs last?
Legal final maturity: 12-13 years typically. Actual life: Often shorter:
- Reinvestment period: 4-5 years (active management)
- Amortization period: 5-7 years (passive runoff)
- Optional call: Equity may call the CLO after 2-3 years if portfolio has deleveraged
Learn more about CLO lifecycle →
Comparison Questions
CLO ETFs vs. High-Yield Bond ETFs: Which is better?
| Feature | CLO ETFs (JAAA, CLOZ) | High-Yield Bond ETFs (HYG, JNK) |
|---|---|---|
| Yield | 6-9% (AAA-mezzanine) | 6-8% |
| Duration | Low (floating-rate) | Moderate (fixed-rate) |
| Credit Quality | AAA-BBB (via subordination) | BB-B (direct exposure) |
| Default Protection | Structural (subordination, OC/IC tests) | None (direct bond exposure) |
| Rate Sensitivity | Low (benefits from rising rates) | High (loses value when rates rise) |
Bottom line: AAA CLO ETFs offer better risk-adjusted returns than HY bonds. Mezzanine CLO ETFs (CLOZ) compete directly with HY but with structural protections.
CLOs vs. Direct Leveraged Loans?
CLOs own structured securities backed by loans. Direct loan funds (LOAN ETF) own the actual loans.
- CLO advantage: Structural protections (subordination) make AAA CLOs safer than direct loan exposure
- Loan advantage: Simpler structure, no tranche complexity
- Yield: AAA CLOs yield ~6-6.5%; direct loans ~7-8%; mezzanine CLOs ~8.5-9.5%
Market and Manager Questions
Who are the best CLO managers?
Tier 1 managers (achieve tightest debt pricing, best track records):
- Ares Management
- Blackstone Credit
- Oak Hill Advisors
- PGIM
- Golub Capital
- Carlyle Group
Manager tier impacts:
- Debt pricing: Tier 1 achieves 20-40 bps tighter spreads
- Equity returns: Tier 1 outperforms by 200-400 bps IRR
- Liquidity: Tier 1 CLOs trade more actively in secondary markets
Learn more about manager evaluation →
How do I evaluate a CLO before investing?
Key due diligence factors:
- Manager track record: Historical default rates, equity IRRs, coverage test failures
- Portfolio quality: Weighted average rating factor (WARF), CCC exposure (< 7.5%), industry diversification
- Structural protections: OC/IC trigger levels, call provisions, covenant package
- Vintage: Avoid late-cycle vintages (e.g., 2007, likely 2024-2025)
- Pricing: Compare spreads to market benchmarks for similar managers
Still Have Questions?
Explore our comprehensive guides:
- What is a CLO? – Foundational overview
- CLO Structure – Capital stack and waterfall
- CLO ETFs – Retail investor guide
- Historical Returns – 30 years of performance data
Disclaimer
This FAQ is for educational purposes only and does not constitute investment advice. CLO investing involves risks including potential loss of principal. Consult qualified financial advisors before investing.