ETFs Focused on Collateralized Loan Obligations Rise

The $1.2 trillion collateralized loan obligations market is moving toward individual investors and financial advisors in ways that can make sense as a cash alternative or alternative income source.

There are fewer than a dozen ETFs offering exposure to CLOs, but demand is likely to rise as more investors recognize the level of security paired with yields above risk-free rates. 

Getting past the perceived complexity of CLOs just means seeing them as pools of floating rate corporate loans that are both senior and secured on corporate balance sheets.

It is also worth noting that CLOs should not be mistaken for CDOs, or credit debt obligations, which are structured credit instruments that blew up during the 2008 financial crisis.

Triple-A rated CLOs are currently yielding around 6.5%, which is about 120 basis points over the risk-free Secured Overnight Funding Rate.

Moving down a few notches in credit quality to double-B and triple-B CLOs generates yields of nearly 10%.

CLO specialist John Kim, chief executive officer at Panagram Structured Asset Management, said the credit spread over the risk-free rate is what investors should focus on.

“They are floating, and in a rising-rate environment you get more yield,” he said. “But absolute yield is not what you should be thinking about; you should look at how much extra yield you get over the risk-free rate.”

CLOs Carving a Niche in ETF Wrapper

Panagram, which manages nearly $16 billion worth of CLO portfolios mostly for institutional investors, entered the ETF space last year with two funds designed to give retail investors access to this otherwise obscure asset class.

The $220 million Panagram BBB-B CLO ETF (CLOZ) was launched in January 2023, and the $55 million Panagram AAA CLO ETF (CLOX) was launched in July.

The assets might seem low, but they stack up well against similar ETFs issued by larger, more established firms.

For example, the BlackRock AAA CLO ETF (CLOA) has grown to $103 million since launching in January 2023 and the Invesco AAA CLO Floating Rate Note ETF (ICLO) has grown to $58 million since launching in December 2022.

The dominant player in the category, at $6.8 billion, is the Janus Henderson AAA CLO ETF (JAAA), which launched in October 2020.

But even the Janus Henderson B-BBB CLO ETF (JBBB), which started in January 2022, is still at around $212 million.

Regardless of the ETF used to gain access to the market, Kim of Panagram believes exposure to CLOs adds unique characteristics to a diversified portfolio.

“CLOs have less than 50% correlation to a 60/40 portfolio,” he said. “And there’s never been a triple-A rated CLO default.”