Global credit funds & CLO's
November 2023 | Issue 259
Published in London & New York.
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November 2023 | Issue 259
Analysis
CLO ETFs
From zero to hero
Tom Davidson
Managing editor
CLO ETFs have grown into a $5bn market and proved their worth in difficult periods. We sat down with managers in the space to discuss these achievements — and what the future holds
Tom Davidson, Creditflux:
How have CLO ETFs performed over the past year?
John Kerschner:
For me, CLO ETFs were a huge hero last year in one of the most difficult investing markets we’ve seen in a hundred years. Against that backdrop, our AAA CLO ETF was actually positive on the year by about 50 basis points. Our BBB CLO ETF was down slightly, but still much better than most fixed income and equities.
It’s amazing how many financial advisors reached out to thank us. When you have a portfolio where everything’s down, it’s really nice to point to a product that was positive.
This year rates have gone up, particularly at the long end. That means that JAAA, our AAA CLO ETF, is probably not outperforming every fixed income fund out there, but at about 6.5% it looks strong. Down the capital stack, our triple B CLO ETF is now ranked sixth year to date, with close to 11% yields.
Given the fact that interest rates have been trending higher and the Fed is talking about higher for longer, we think floating rate in the portfolio makes a lot of sense. And one of the best places to do that right now is CLOs.
Ian Gilbertson: I’ll piggyback off that and mention that it’s nice to have conversations with investors introducing our ICLO ETF when you can say we’ve got 6.8% total return year to date, which annualises to 8.3% for a triple A rated product, as of 27 October 2023.
Edwin Wilches: The only thing I would add is that, outside of CLOs doing well in general, there’s been more managers throwing their hats in the ring. The total return of all these funds is tracking the index pretty well, in some cases outperforming it. I think that’s important for the client to experience.
“With ETFs, the price you pay to get in and out is much more transparent”
John Kerschner, Head of US securitised productsr | Janus Henderson Investors
TD:
Ian, you mentioned institutional investors. What’s the split between them and retail money in your ETF?
IG:
Based on the experience we had with our BKLN ETF, it’s still a little early for adoption by retail money. When BKLN launched as the first bank loan ETF in 2011, we saw the largest adoption by institutional investors first, and that drove a lot of the size and scale of the underlying growth of the ETF, which then led to additional retail adoption.
EW: We’re seeing different types of institutional investors talk to us. You have family offices, traditional financial advisors, and the larger RIAs that behave more like quasi-institutional investors. Additionally, we’re seeing pension plans reach out, as well as insurance folks expressing interest, as some ETFs can get recognised as bonds by NAIC.
JK: Janus Henderson is more retail focused than some of the other companies here, so we have found a high uptake by retail investors, at least at the AAA level, where the story is fairly simple. It’s high credit quality but floating rate, and a great diversifier. Once you get through the talk of how a CLO is not a CDO, people get comfortable quickly.
I do think the institutional channel, notwithstanding what Ian said about the bank loan market, has been a little bit more reticent to jump in feet first, just because people aren’t as familiar with the CLO market.
*as of 27 October 2023
TD:
What’s the growth potential for these products?
JK:
We get this question all the time. Look, US CLOs are a trillion-dollar market. The European market is a couple of hundred million on top of that. And yet there’s still only a handful of liquid products, and a lot of them are still quite small. There’s a huge amount of room for growth. We won’t be getting close to tapping out until the combined CLO ETF market gets to $20 or $30 billion.
IG: There’s plenty of white space for growth. Some funds have launched in 2022, a few more in 2023, and I expect there to be additional CLO ETF launches in the future. But CLO ETFs all combine for a total of about 50 basis points of the CLO market.
EW: If the ETF market ends up being 5% or 10% of the overall market, that doesn’t sound too big. That translates to anywhere between $50 and $100 billion.
“We’ve got an 8.3% annualised return for a triple A rated product”
Ian Gilbertson, Co-head of US CLOs | Invesco
TD:
What are the challenges or constraints in managing an ETF structure?
EW:
We haven’t found any. We’ve managed CLOs within mutual funds for a long time, so we’re used to giving our clients the required transparency. We’re used to working with third-party vendors for pricing. So for us, it’s been a natural and easy extension.
JK: The salient point is that the ETF is just a wrapper. If you’re a portfolio manager in the space, you know how to underwrite risk and price risk. Similar to Ian, we have a world-class capital markets team which has helped us get up to speed.
We get a lot of questions from investors who haven’t invested in many ETFs, especially about creates and redeems. If you’re looking at a 40 Act fund, people don’t necessarily see the bid/ask that you see in ETFs, but it’s there, just a little more hidden. That’s what I like about ETFs: the price you pay to get in and out is much more transparent.
We get a lot of questions from investors who haven’t invested in many ETFs, especially about creates and redeems. If you’re looking at a 40 Act fund, people don’t necessarily see the bid/ask that you see in ETFs, but it’s there, just a little more hidden. That’s what I like about ETFs: the price you pay to get in and out is much more transparent.
TD:
How much do you have to rely on the secondary market?
IG:
In five or 10 years, we definitely want to have access to both the primary and secondary markets, but we’re doing entirely secondary purchases right now. When you’re doing a primary purchase and you have a six-week period from pricing to closing that’s a tremendous cash drag for an ETF.
EW: We use both. It depends on the market environment. We are always looking for best relative value. When we were ramping our ETF, we really loved the discount available in secondary. We’re focused on not just the yield, but also the total return. That being said, we are a large anchor investor. Our total CLO portfolio is close to $60 billion. So we do have a high degree of access to primary and influence in the docs for the benefit of our clients.
“We’ve had increasing enquiries from Europe — that is another frontier for CLO ETFs”
Edwin Wilches, Co-head of securitised products | PGIM Fixed Income
TD:
The liquidity requirements for triple A CLO ETFs is well discussed, but do you have any concerns further down in the triple B space?
JK:
While there’s less liquidity in a triple B tranche, it’s still a fairly liquid market, with a couple of hundred million dollars trading every week. We also manage things with redemption fees that are higher on JBBB than they are on JAAA, and we are able to change them depending on market circumstances. Again, I think it really just goes to the fact that this market, even lower down the capital stack, is more liquid than people think.
EW: Before we finish, I want to add that we’ve had increasing enquiries from Europe. I think that is another frontier for CLO ETFs.
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