Exchange-traded funds have not been part of the global CLO market for long. The first were launched as recently as 2020 in the US and 2024 in Europe.
Designed to invest in bonds issued by collateralised loan obligations, these funds function much like other ETFs. But where many ETFs are passive, most CLO ETFs are actively managed.
While fund managers loosely track CLO indices like those produced by JP Morgan or Palmer Square Capital Management, they do not replicate them.
Reproducing a CLO index is difficult, as the presence of large buy-and-hold investors can make it nearly impossible to buy some CLOs.
There has been much head scratching over how to regulate CLO ETFs. European regulators have — not surprisingly — taken a more conservative line than their US counterparts.
In the US, ETFs can invest in the entire CLO capital stack. They are also open to retail investors.
European regulations demand that at least 80% of a CLO ETF’s assets must be triple-A notes, and fund managers have only a limited ability to invest in other tranches.
And CLO ETFs cannot be marketed to mass retail investors in Europe. The closest they get is wealthy individuals with brokerage accounts at private banks.
European regulators’ caution is warranted. CLO ETFs are aimed at investors often unable to access the CLO market directly, such as family offices or smaller pension funds.
Direct investments in CLOs typically requires taking large positions that often exceed these investors’ capacity.
Many CLO ETF buyers are, therefore, less familiar with the underlying assets than regular CLO investors — so keeping them mainly in the least risky tranches makes sense.
CLO triple-As usually have as much as 38% credit enhancement below them, making defaults exceptionally unlikely.
Another reason to restrict investment mainly to triple-A paper is the double layer of intermediation distancing the ETF holder from the ultimate investment: leveraged loans.
Both CLO managers and the ETF manager stand between the investor and the raw assets, making it hard to peer into the risks being taken.
Given the complicated nature of these instruments, it also makes sense for European regulators to shield retail investors from them, at least until there is more data about their performance.
Liquidity worries
European regulators’ greatest anxiety about CLO ETFs is liquidity.
The funds have to offer investors daily liquidity. How easy this is to fulfil depends, to an extent, on the liquidity of the market for CLO bonds.
A perceived rise in credit risk can make liquidity dry up. When fears about the impact of artificial intelligence on software companies’ revenues emerged in early February, trading in CLOs slowed.
There is also a secondary market in CLO ETF units. That can make them less reliant on the liquidity of the CLO market than mutual funds, which have to match all investments and redemptions with asset purchases or sales.
Nonetheless, when demand for CLO ETF shares outstrips or falls short of secondary market supply, new shares have to be created or redeemed, by buying or selling CLO notes.
Creating shares involves CLO ETFs’ authorised participants (APs) handing CLO liabilities to the ETF issuer in return for ETF shares, while redemptions reverse this process. Creating and redeeming shares in this way keeps the CLO ETF market price close to its net asset value (NAV).
A liquidity crunch in the CLO market could make the ETF machine to grind to a halt.
A fall-off in secondary market demand for CLO bonds or CLO ETF shares could make it tough for fund managers to provide daily liquidity to investors.
European regulators have rightly tried to ward off liquidity risks by constraining CLO ETFs to triple-As. Triple-A notes make up over 60% of the CLO market and have a large enough investor base that they usually stay liquid through times of market volatility.
European CLO ETFs have a short history, but the US market provides useful evidence.
US CLO ETFs have endured through the Covid-19 pandemic, the inflation of 2022 and the US tariffs imposed in April 2025. Research from investment firm PGIM points out that CLO triple-As continued to trade actively through these stresses.
Lighter touch
European regulators have done well to introduce CLO ETFs slowly, under strong safeguards.
However, there is room to loosen these restrictions if the market builds up a solid track record.
Managers could gradually be allowed to invest a little further down the capital stack, while still mandating a high minimum triple-A allocation.
This would allow investors to benefit from higher spreads. Regulators could exclude junior mezzanine tranches for added protection.
At roughly €1.4bn, the European CLO ETF market is a fraction of the size of the $33bn US market. Expanding the funds' reach to investment grade mezzanine tranches would likely draw in more investors, growing the market.
The additional risk would be slight. There has never been an impairment to a European CLO debt tranche since CLOs were relaunched after the 2008 global financial crisis.
While mezzanine notes are less liquid, this risk is partly offset by the fact that most CLO ETFs pay monthly or quarterly dividends. Returns are not solely determined by the ability to sell out of positions as investments appreciate.
Even CLO ETFs that invest only in triple-As can offer appealing returns.
The Janus Henderson AAA CLO ETF makes up close to 70% of the US market. It made annual returns of 8.58% in 2023, 7.41% in 2024 and 5.18% in 2025.
Investors would be hard pressed to find returns at those levels from any other triple-A rated asset class.
ETFs, invested in other investment grade CLO tranches could earn even more.
Regulators in Europe should continue their tentative approach, relaxing rules only if CLO ETFs perform well.
CLO notes pay attractive spreads precisely because they are complex. Any softening of rules should still reflect that complexity.
But, while caution is prudent, there is an unexploited opportunity here, which a wider range of European investors could benefit from — to the ultimate benefit of companies financed with leveraged loans.