Why CLO ETFs Are Picking Up Steam

Collateralized debt obligations got a bad rap from movies like “The Big Short.” But the story could be different for their cousin, collateralized loan obligations

Issuers are diving into the world of exchange-traded funds that invest in CLOs. Janus Henderson recently filed with the Securities and Exchange Commission to launch another CLO strategy, while Reckoner Capital Management proposed four such ETFs earlier this month. The appeal stems from their high yields relative to other bond funds and the recent period of high interest rates. The new funds also reflect investors’ appetite for risk-on strategies as more of these products enter the arena.

“During that rising rate period … [CLO ETFs] just happened to stand out as an asset class that people thought was interesting,” said Paul Olmsted, senior analyst of fixed income strategies at Morningstar. “It’s a yield play.”

CLO Clones

The new Janus fund will invest in AA- and A-rated CLOs, which are higher risk than AAA bonds (that have never defaulted) but could also potentially yield higher returns. Janus Henderson was the first to offer CLOs in an ETF wrapper, launching JAAA in 2020 and giving investors access to a broad array of collateralized loan obligations, or investments in companies that make loan payments; investors see yield when the corporations pay off their debts. Other funds from BlackRock (CLOA) and VanEck (CLOI) hit the market in 2022 and 2023, respectively.

The three largest CLO ETFs available today include:

• Janus Henderson’s AAA CLO ETF (JAAA), which has roughly $25 billion in assets and is up 3.8%.
• The PGIM AAA CLO ETF (PAAA), which has $4.5 billion in assets and is up 4.3% year to date.
• The iShares AAA CLO Active ETF (CLOA), which has $1.3 billion in assets and is up 4.2% year to date.

Go With the CLO: The recent surge of CLO strategies may also stem from a growing interest in private credit, and the expansion of institutional-grade investments to retail investors. Still, there is always some risk involved in CLO investments, particularly lower-grade loans (like BBB or BB loans), even if corporations are the ones paying the loans. Olmsted advises to “stick with the bigger ones.”

“It’s so important that people are doing their due diligence,” Olmsted said. “If you look at some of the smaller names out there, just be aware and make sure that they have a reasonable track record.”