ETFs charge into collateralised loan obligations

The drive for diversification is pushing more innovation in the market. Since the first two US exchange traded funds offering exposure to collateralised loan obligations launched in 2020, seven more have come to market, Morningstar data shows.

In all, the ETFs have about $2.8bn in assets under management.

CLOs performed strongly during the Federal Reserve’s recent tightening cycle compared with the broader investment-grade bond market, said Bryan Armour, director of passive strategies research for North America at Morningstar Research Services. This echoes what happened during and after the 2008 financial crisis, he noted.

Since the financial crisis, investment managers have also adopted more types of CLOs into their investment portfolios, such as triple A rated CLOs, since they provide “high-quality, floating-rate exposure with a history of stable performance”, Armour said.

“It’s just been a way for managers to take something that is potentially riskier, but to go into higher-quality debt,” he said.

“That’s why, for example, with ETFs, we’ve seen a lot of triple A-only CLO ETFs, for example. I really think that rather than building out the infrastructure to analyse and do a bottom-up analysis on all these individual securities, adding this beta exposure as a building block for managers might make some sense for institutions,” he added.

Janus Henderson debuted one of the industry’s first CLO ETFs in October 2020. The ETF, the Janus Henderson AAA CLO ETF (JAAA), is the industry’s largest such ETF, with about $2.7bn in assets.

“The idea was to bring active management to the mortgage-backed security market, in an ETF wrapper,” said John Kerschner, head of US securitised products at Janus Henderson and portfolio manager for the ETF. “To our surprise, [CLO ETFs] did not yet exist.”

Last year, the firm launched its second CLO ETF, the Janus Henderson BBB CLO ETF (JBBB), which has about $81mn in assets.

Launching products in a less crowded asset class could help the firm stand out among other ETF providers, Kerschner said.

“We know we’re a little bit of a niche player in the ETF world,” Kerschner said. “We’re not out here to compete with the iShares of the world or the Vanguards of the world.’”

With a looming recession, which Kerschner predicts will be in the next three to six months, he understands if people are hesitant about getting into debt strategies.

“We’re telling people that the great thing about securitisation — whether it’s auto loans, credit cards, student loans, mortgages, commercial mortgages — all you’re doing is taking a portfolio of leveraged loans here and securitising the cash flows and dividing up different levels of risk,” he said.

Other large fund managers have launched CLO ETFs over the past year, including Invesco, which sponsors the $32.9mn AAA CLO Floating Rate Note ETF (ICLO), and BlackRock, which has the $30.2mn AAA CLO ETF (CLOA).

ETFs are not the only vehicles that managers are eyeing for CLOs. Several managers have also recently disclosed plans to put the debt-backed security in an interval fund wrapper, a type of closed-end mutual fund.

Last month, SEI filed for its first interval fund, the SEI Alternative Income Fund. The fund will invest in CLOs, structured notes and warehouse facilities, the firm disclosed.

Earlier this year, Flat Rock Global, a $600mn alternative credit manager, debuted its third interval fund, the Flat Rock Enhanced Income Fund, which invests in CLO BB notes.

Credit is the largest-growing category for interval funds, according to data from Interval Fund Tracker. The 54 funds in the category had a combined $30.7bn in net assets at the end of 2022. Assets in credit interval funds grew by 63.7 per cent in 2022, data shows.