The VanEck CLO ETF (CLOI) is celebrating its three-year anniversary. We recently held a client event with the ETF’s sub-advisor, PineBridge Investments, to discuss their outlook, CLO market trends and how they are positioned for uncertainty ahead. This Q&A summarizes their discussion.

• How is your economic outlook impacting portfolio positioning?
• How would lower interest rates impact CLOs?
• What are the long-term default rates of CLOs?
• What is PineBridge’s process for selecting CLOs?
• How is sector exposure managed in a CLO tranche portfolio?
• What role does the equity tranche play in CLOI or CLOB?
• How many defaults in the CLO portfolio does it take to impair a CLO debt tranche?
• What has recent CLO issuance been like?
• Do CLO ETFs face capacity constraints?
• How are advisors using CLOs in portfolios?
• What is the impact of loans being called on CLOs?
• Have CLO ETFs impacted the overall CLO market?
• Have credit cycles changed versus history?
• How have CLOs evolved since the GFC?

How is your economic outlook impacting portfolio positioning?

Based on current economic data, our base case scenario is for a slowdown but no recession. Issuer fundamentals remain strong. Earnings are moderating but aren’t falling off a cliff, so corporate balance sheets are well positioned to withstand a moderate downturn. However, markets have rallied back since the turbulence in April and valuations for a lot of credit assets have tightened back to February/early March levels.

That said, we believe this optimistic backdrop is discounting several downside risks:

• Uncertainty around tariffs and trade policy: This is still very fluid between varying rulings in the courts and pivots from the administration during trade deal negotiations. If things get more combative, we could see renewed pressure on prices and if tariffs were sustained at higher levels, we could ultimately see deterioration in credit metrics.
• Inflation: This seems poised to move higher in coming quarters as the impact from the trade policies that are already enacted come into effect. Inflation is still above the Fed target and our expectation is that we see an increase over the coming quarters.
• Higher for longer rates: Higher inflation would lead to the third potential downside risk for the economy, which is that rates stay higher for longer. With trade policy and the ultimate impact on inflation still a question mark, we believe the Fed is inclined to wait and see what the data shows before acting. Weaker loan borrowers that couldn’t refinance over the last two years may experience adverse outcomes, something we’ve already seen a bit of given elevated default rates (including distressed exchanges) in the leveraged loan index. However, it is important to note this is a mixed bag as higher base rates means higher coupons for floating rate debt investors. From a CLO debt investors perspective, if rates stay higher without causing a massive spike in defaults, this could be a good outcome overall.
• Eroding consumer sentiment: Although the consumer has remained resilient, consumer sentiment data has been relatively weak, and projections for an increase in unemployment could further erode confidence and ultimately lead to a decrease in spending.
• Fiscal policy uncertainty: Fiscal developments in the U.S. may push long end rates higher and increase the cost of long-term capital.

For now, these risks are primarily on the horizon, so until we see any of the impacts play out, we are constructive on credit metrics overall in the short term. However, given tight valuations and multiple downside risks, we believe the backdrop is tilted toward widening rather than significant tightening in the medium term.

Notwithstanding the more recent de-escalation of trade tensions, we prefer higher-quality tranches and are selectively purchasing shorter spread duration assets for lower rated credits. This is due to signs of economic weakening in the U.S. and the continued prospects of a global trade war. We believe current AAA spreads are tight, so given our quality bias, we believe adding AA and A rated securities makes the most sense. We expect additional bouts of volatility throughout the year and would like to maintain the ability to shift further into lower rated tranches during future periods of market weakness.

How would lower interest rates impact CLOs?

CLO yields, as floating rate assets, adjust quickly to Fed policy rate changes. While a lower rate environment reduces yields, CLOs still offer relative advantages like higher Sharpe Ratios, superior yield-to-risk and a higher spread compared to similarly rated corporate bonds. This spread and yield advantage has been maintained across credit cycles and interest rate regimes, and we expect that to continue going forward.

We believe CLOs can help income investors benefit a diversified income stream from their portfolios which provides an attractive return relative to the degree of risk taken. We also note that inflationary pressures will likely keep rates high for the foreseeable future, in our opinion. If rates were to be cut more aggressively, that would likely be reflective of a more adverse economic environment than the market is currently expecting, which would likely be accompanied by significant spread widening, which would offset the impact of rate cuts. Such an environment can provide opportunities for a flexible investment strategy to add risk after a selloff and continue to provide attractive absolute yield levels.

What are the long-term default rates of CLOs?

Default rates for CLOs and corporate debt diverge significantly by rating. Over a 10-year horizon, CLOs rated BB have cumulative impairment rates of about 3.1%, while similarly rated corporates average 15.4%.

More broadly, speculative-grade (SG) corporate bonds exhibit 30.3% default rates over 10 years. This underscores the historical resilience of CLOs, especially in the investment-grade range, which has shown near-zero impairments over multi-year horizons. We note that no Aaa or Aa rated has ever had an impairment, and since the global financial crisis, no investment grade tranche has ever defaulted—this is due to the more robust structures of CLOs (more on this later).

Default Rates for CLOs vs. Other Forms of Corporate Credit, 1983 - 2023

CLOs

Source: Moody's Ratings.

Average cumulative issuer-weighted global corporate default rates by letter rating

Source: Moody's Ratings.

What is PineBridge’s process for selecting CLOs?

PineBridge applies a highly analytical and multi-layered investment process when selecting CLOs, focusing on four primary factors: manager quality, deal structure, documentation, and underlying loan credit quality. At the core of the process is a deep evaluation of the CLO manager, where only managers with proven, disciplined credit processes and strong risk oversight are considered. PineBridge avoids managers with weak performance histories, unstable platforms, high default or low recovery rates, or no long-term equity placement plans.

The investment team conducts in-depth structural and documentation analysis and utilizes its proprietary credit platform to map every underlying loan to its internal credit ratings and research. This enables a granular understanding of each CLO’s risk profile. Further scrutiny is applied via tools that allow us to model default/loss simulations, rate sensitivity, reinvestment dynamics, and spread/maturity stress testing—especially critical for mezzanine and equity tranches.

Ultimately, every potential investment is re-underwritten and summarized in a CLO Tranche Investment Report, which guides security selection. This is complemented by PineBridge’s experience managing 41 CLOs globally, offering an “insider” view into best practices when managing CLOs. Each potential tranche investment opportunity is then reviewed by the CLO Credit Committee, to determine our degree of comfort within the CLO.

Additionally, PineBridge also avoids CLOs where the manager has exhibited poor credit selection, the portfolio has had heavy losses, market pricing appears overvalued or if we believe the tranche has a high probability of being downgraded.

How is sector exposure managed in a CLO tranche portfolio?

CLOs benefit from sector/industry limitations within the transaction, so there are no further limitations within the CLO Tranche portfolio. Industry exposure typically reflects the overall loan index of each vintage (after accounting for these limits), and active management allows the CLO manager to avoid riskier issuers or those that do not offer attractive value. In addition, PineBridge overlays its strategic views on issuers and industries on the CLOs that are considered for investment or are in existing portfolios.

Current CLO Holdings by Moody's Industry

Change in CLO Holdings Over Time

Source: Kanerai, Intex, Markit, Barclays as of May 31, 2025. Diversification does not ensure against market loss. For illustrative purposes only.

What role does the equity tranche play in CLOI or CLOB?

VanEck CLO ETF (CLOI) and VanEck AA-BB CLO ETF (CLOB) do not invest in equity tranches. However, historical performance of the equity tranche is a key factor in our manager due diligence and ranking process. Metrics like equity NAV inform manager assessments and purchase evaluations, and also provide an indicator of the portfolio quality of existing holdings.

How many defaults in the CLO portfolio does it take to impair a CLO debt tranche?

Breakeven annual default rates to impair holdings range from ~52% for AAA to ~6% for BB-rated tranches. These default rates would need to be maintained for several consecutive years to experience the first dollar of loss. Despite a recent rise in default-related activity to about 4%, default risks remain well below the breakeven levels for most investment-grade tranches. Stress testing incorporates conservative assumptions including lower recoveries, increased CCC exposures, and a recovery lag.

Stressed Default Rates to Incur Loss, by Credit Rating

PineBridge Investments analysis as of 1/31/2025 and J.P. Morgan for Leveraged Loan Annual Default Rate (2001-2024). Based on PineBridge CLO Tranche Strategy Holdings. Any views represent the opinion of the investment manager, are valid as of the date indicated and are subject to change. Past performance is not indicative of future results. This is not an offer to buy or sell, or recommendation to buy or sell any of the securities mentioned herein.

What has recent CLO issuance been like?

CLO issuance rebounded in May following April volatility tied to tariff announcements. Spreads widened temporarily but didn’t get anywhere near the widest of other historical market shocks given that they were starting from low levels. Since this period of widening, they have retraced. With the market whipsawing, we saw the primary market cool as investors were waiting for volatility to die down and have greater visibility on clearing levels. Ultimately, issuance has remained strong—second only to last year’s record. However, refi/reset activity slowed, as in-the-money deals became less attractive, and paydown activity has been elevated leading to flat net AAA supply. That said, the percentage of CLOs out of their reinvestment period has declined, so paydown could start to ebb compared to the prior few quarters.

Do CLO ETFs face capacity constraints?

There are no current capacity concerns for CLO ETFs like CLOI or CLOB. The available investable universe, especially when targeting the top 25% of deals, remains vast, with over $983 billion in U.S. and €265 billion in European CLOs outstanding, leaving ample room for asset growth.

How are advisors using CLOs in portfolios?

Total assets in CLO ETFs have grown from zero to nearly $30 billion in five years. Although the CLO market itself has been around since the 1990’s, most advisors were not able to access CLOs until these ETFs were launched. The liquidity and transparency benefits of the ETF structure make CLO ETFs useful tools in the portfolio construction process, allowing advisors to take advantage of the benefits that CLOs can provide - something that institutional investors have been doing for many years. Accordingly, we have seen most advisors using CLOs as a strategic allocation in their fixed income portfolios. In general, we have seen advisors primarily using CLOI within their core bond portfolios to enhance yield and provide diversification, while maintaining a high credit quality. CLOB is an attractive complement to a high yield portfolio, or as a higher quality alternative to a leveraged loan investment.

What is the impact of loans being called on CLOs?

Loans getting called has pros and cons for CLOs depending on where you invest in the capital stack. For AAA and senior tranche investors, increased call activity results in a faster deleveraging of the structure, especially for CLOs that are outside their reinvestment period. Investors get their capital back faster, reducing the overall spread duration of their investment. However, for junior tranches and equity investors, a loan prepayment/refi wave could potentially lead to adverse selection and subsequently higher tail risk in a CLO that is outside of the reinvestment period. Also, the excess weighted average spread that helps provide indirect subordination to CLO debt tranches tends to shrink when capital markets allow elevated levels of loan refi/prepayment activity.

Have CLO ETFs impacted the overall CLO market?

While the CLO ETF market has grown significantly, it still represents only ~3% of the U.S. CLO market overall, limiting their market impact. Past volatility hasn't indicated any ETF-driven systematic spread volatility, but as ETF presence grows, it is possible that their market impact could rise. CLO ETFs went through their first significant period of market stress in April following the “Liberation Day” tariff announcements and experienced meaningful outflows for the first time since these products have been around. We believe that CLO ETFs performed as expected and, and we did not observe any issues satisfying redemptions or disruption to the underlying CLO market.

Outside of market volatility events like we saw in April, we do believe the marginal demand from CLO ETFs can have incremental impacts on relative value across the CLO capital stack. This is due to large, ratings-constrained ETFs that are limited to buying (or selling) CLOs with a single rating. For example, following significant inflows in 2024 and into 2025 into AAA CLO ETFs (and strong demand generally), that rating category appeared rich, in our opinion. For this reason, we believe that for most investors, an active approach that has flexibility to invest more broadly throughout the CLO capital structure can provide better outcomes.

In general, we believe the growth of CLO ETFs has been a positive catalyst for the CLO market. CLOs have historically been restricted to institutional investors, so the creation of CLO ETFs opens the market to a swath of new potential investors, such as smaller institutional investors that didn’t have the assets for a separately managed account and retail investors. Further, CLO ETFs enhance liquidity and price discovery in the market. Other areas of fixed income like high yield and municipal bonds, among others, experienced this change over the past two decades as ETFs became meaningful participants in those markets, and we believe we are seeing the same evolution in CLOs.

Have credit cycles changed versus history?

While credit cycles haven’t fundamentally changed, their pace has quickened, requiring more agility. PineBridge’s flexible ETF strategies and ability to invest across the capital stack offer an edge in rapidly shifting environments, enabling quicker positioning based on evolving sentiment and news. In addition, we believe flexibility offered to invest in different parts of the capital stack gives us an advantage in this environment as we are able to quickly adjust our positioning as market conditions change.

How have CLOs evolved since the GFC?

CLOs originated in the late 1980s (similar to other types of securitizations) as a way for banks to package leveraged loans together to provide investors with an investment vehicle with varied degrees of risk and return to best suit their investment objectives. Following the Global Financial Crisis (GFC), CLOs evolved significantly to enhance structural resilience and investor protection. The pre-crisis "CLO 1.0" vintage often included high yield bonds and had looser reinvestment and credit standards. Post-2010, CLO 2.0 emerged with stronger credit support and shorter reinvestment periods, responding directly to the weaknesses exposed during the crisis.

In 2014, CLO 3.0 introduced further safeguards, such as stricter adherence to the Volcker Rule, removal (or strict limits) on high-yield bonds, and increased subordination levels to protect debt investors. Although the Volcker Rule was amended in 2020 to allow limited high-yield exposure, most modern CLOs cap this at 5–10%, maintaining stronger protections. These structural shifts have made CLOs more transparent, resilient, and investor-friendly post-GFC.

Pre-Crisis vs. Post-Crisis

CLO Capital Structure¹

Sources: Citibank, as of 30 September 2021.

Note: All data is median of Q4 2020 vintage deals, thus tranche thickness does not add to 100%. Any views represent the opinion of the manager and are subject to change. Diversification does not ensure against loss. For illustrative purposes only.

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