Understanding CLOs
Collateralized Loan Obligations (CLOs) have become a core part of the modern fixed income toolkit, offering several compelling advantages for investors seeking diversification, yield, and resilience across market cycles. Outside of Canada, CLOs are a large, fast-growing market. J.P. Morgan estimates that the U.S. CLO market has grown to over USD$1 trillion1. To help investors become more familiar with this opportunity, Brompton and CLO experts at Wellington Square Advisors Inc. have prepared the following FAQ.
How big is the CLO market?
The global CLO market reached the $1T benchmark size1 in 2021 and is now approximately equal in size to the U.S. high yield bond market.
While banks and insurance companies are the primary institutional owners of CLOs historically, retail investors have continued to gain a presence in the CLO market, with over $30B2 in CLO AUM across ETFs.
$30B
in CLO AUM across ETFs
What is the difference between CLOs and CDOs?
CLO (Collateralized Loan Obligation) and CDO (Collateralized Debt Obligation) are both types of structured financial products, but they have key differences in terms of the assets they are backed by and their structure:
CLOs ≠ CDOs
Underlying Assets
CLO (Collateralized Loan Obligation): CLOs are primarily backed by a portfolio of publicly traded, senior-secured corporate loans, which are typically below investment-grade. These loans can be for mergers, acquisitions or other corporate purposes.
CDO (Collateralized Debt Obligation): CDOs are backed by other types of debt instruments, typically sub-prime mortgages and other types of securities.
Structure
CLO: CLOs invest in a portfolio of corporate loans. CLOs raise capital to buy their loan portfolio by issuing bonds that are tiered in rated tranches, with the most senior tranche of CLO bonds rated AAA, followed by progressively junior tranches rated AA, A, BBB, and BB. An equity tranche is also issued, which is the most junior of all CLO capital raised and is subordinate to all bond tranches. Senior bond tranches receive coupon and principal payments first and are protected from potential losses in the corporate loan portfolio by the more junior tranches. Returns for each tranche are commensurate with risk levels, with the more junior/riskier traches receiving higher coupon payments that the more senior tranches with higher credit ratings.
CDO: CDOs are structured similarly to CLOs, with debt and equity tranches that vary in risk and return.
Risk Profile
CLO: CLOs are narrowly focused on investing in diversified portfolios of corporate loans. These corporate loans are the most senior part of the corporate loan issuer’s capital structure and are secured by the company’s assets. The seniority of corporate loans gives them a priority claim on the assets of the issuer ahead of all other debtors, which has resulted in robust recoveries for loans even when issuers default. The senior-secured nature of corporate loans translates into relatively low defaults for CLO bonds. For example, AAA-rated CLO bonds have never experienced a default over their history.1
CDO: CDOs can invest in a broader variety of asset classes which may be more risky than corporate loans. CDOs that included a large allocation to subprime mortgages are widely regarded as triggering the Global Financial Crisis, largely due to the risky nature of the underlying holdings.
How did CLOs behave during 2008 Global Financial Crisis?
One common misperception is that CLOs are excessively risky and contributed significantly to the 2008 Global Financial Crisis (the ”2008 Crisis”). This confusion arises because of their similarity with CDOs in terms of structure and nomenclature, and the latter’s reputation for being a major contributor to the crisis. In fact, not only did CLOs have little to do with the 2008 Crisis, the asset class thrived through the 2008 Crisis relative to other fixed income asset classes1. Despite this success, cautious investors demanded even higher levels of protection for senior CLO bonds after the 2008 Crisis, resulting in an even more conservative CLO market in recent years than prior to the GFC.
0 Defaults
throughout the entire history of AAA CLOs1
Through both the 2008 Crisis and COVID-19 drawdown, CLOs ultimately experienced fewer defaults than corporate bonds of the same rating. For example, of the approximately $500B of U.S. CLOs issued from 1994-2009 and rated by S&P, only 0.88% experienced defaults. In the higher rated AAA and AA CLO tranches, there have been zero defaults throughout the entire history of CLOs.1
Is CLO investing better suited for active management?
Replicating an index of CLOs is not practical, and opportunity to add value through active management exists due to the unique characteristics of the CLO market.
The CLO asset class is not homogenous and there are opportunities to add value through security selection and top-down positioning. Specialized knowledge and experience is required to identify these opportunities.
Just one CLO can have over 300 underlying loans and have unique structural features. You need a manager who can drill down and analyze the portfolio at the individual loan-level, in addition to analyzing the CLO manager and understanding and stress-testing the structure itself.
Why should Canadian investors buy a Canadian-listed CLO ETF instead of a U.S. listed CLO ETF?
Tax Complications and Withholding Taxes
Withholding Tax: U.S. distributions paid to Canadian investors by U.S.-listed ETFs are subject to a 15% U.S. withholding tax. This tax can sometimes be avoided in RRSPs due to the Canada-U.S. tax treaty, but not in TFSAs or non-registered accounts.
Canadian-Listed ETFs: Distributions from Canadian-listed ETFs are treated as Canadian- source income, which is not subject to withholding tax and which can simplify tax reporting.
U.S. Estate Tax Exposure
Canadian residents holding U.S.-listed ETFs could be subject to U.S. estate tax on the value of these assets upon death, in addition to Canadian income tax. This risk does not apply to Canadian-listed ETFs, which are considered Canadian assets.
No Manager or Portfolio Manager Support
U.S. listed ETFs don’t have client coverage in Canada. Canadian issuers have wholesaler and investment teams to address any inquiries from advisors.
Additional Tax Reporting Requirement
Canadian investors who hold more than CAD$100,000 (not USD) in U.S. assets need to report foreign holdings when filing taxes by submitting an additional form, the T1135 Foreign Income Verification Statement.
Learn More About Brompton’s Approach
Brompton Wellington Square AAA CLO ETF (BAAA) offers investors access to high quality CLO investments. Historically limited to institutional investors, BAAA makes CLOs accessible at low cost while adding the transparency and liquidity benefits that come with an ETF. BAAA is designed to provide attractive monthly distributions and capital preservation through an actively managed portfolio of primarily AAA rated CLOs. Experienced fixed income and credit manager, Wellington Square Advisors Inc., serves as sub-advisor to the ETF.
Experienced Sub-Advisor
Jeff Sujitno
Portfolio Manager
23 years of credit experience spanning investment grade and high yield markets including CLOs, leveraged loans, securitized debt, and private credit.
Amar Dhanoya
Portfolio Manager
20 years of credit experience with a focus on U.S. and European syndicated loans, yield bonds and CLOs.
Brompton’s CLO PrimerDisclosures
1 S&P Global Default, Transition and Recovery 2023 Annual Study. CLO data for Global Leveraged Loan CLOs. Corporate Data for U.S. Corporates. Published on June 27, 2024.
2 Morningstar Direct, as of March 31, 2025
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