New structured credit ETFs are hitting the market just as investors hunt for income

Published Fri, Feb 3 202312:21 PM ESTUpdated Fri, Feb 3 20232:34 PM EST

The surge of cash into debt funds in 2022 is helping fuel the growth of more esoteric forms of bond ETFs, including two funds launched in January that buy packages of predominantly leveraged corporate loans. BlackRock launched the AAA CLO ETF (CLOA) less than a month ago, and the product already has about $30 million in assets under management. The actively managed fund buys and sells collateralized loan obligations, which are groups of corporate loans that are bundled together into tradable securities. Panagram Structured Asset Management is exploring riskier versions in the same ETF sector, launching the BBB-B CLO ETF (CLOZ) and surpassing the $20 million mark in less than two weeks. "It is a space that has sort of been gathering interest, and it's become a part of more fixed income strategies than I think we would have seen 15 years ago," said Bryan Armour, director of passive strategies research for North America at Morningstar. "One of the big things is that [CLOs] handled the global financial crisis a lot better than some of the mortgage-backed security stuff that we saw, so there's a little more security there for managers and investors. But anytime you have these loans being bought up and split into different tranches, there's always a risk that comes with it," Armour said. Fixed income funds boom The growth of these funds comes after a boom in fixed income ETFs in 2022, as rising interest rates and high inflation sent investors hunting for ways to generate additional yield. Treasury ETFs were the top category for ETF inflows in 2022, with more than $125 billion of new cash, according to Strategas Research. CLOs are floating rate products, which means their yields rose as the Federal Reserve hiked rates last year, with less damage to the value of the underlying assets than traditional fixed income vehicles. "This gives us a pretty good array of floating rate product across the credit spectrum. ... It gives investors a lot of choice in terms of managing that exposure if they want to reduce interest rate risk while still having credit exposure," Steve Laipply, U.S. head of iShares Fixed Income, said of his firm's new fund. John Kim, CEO and chief investment officer at Panagram, said his firm's experience in trading structured credit and the historical success of the products are two of the reasons Panagram launched the BBB-B fund. "You're seeing a raft of ETFs being issued right now to take advantage of the fact that these bonds have performed so well over multiple crises and multiple years, and people want to bring them to a retail audience," Kim said. The most established fund is the Janus Henderson AAA CLO ETF (JAAA) , which only launched in 2020 and already has about $2 billion in assets under management. The fund has healthy trading volume, occasionally topping one million shares in a day. "It's obviously nice that we were first and had basically a two-and-a-half year headstart on all the competition that's now coming out of the woodwork. But we welcome the competition. No large space like CLOs only has one ETF. It's been very expected," said John Kerschner, head of U.S. securitized products at Janus Henderson. "The fact remains that without ETFs it was basically impossible for individual investors to get any kind of exposure to CLOs. ... We think it's an asset class that was ready for primetime," he added. Janus Henderson also has a fund lower down the credit spectrum, the Janus Henderson B-BBB CLO ETF (JBBB). Kerschner said that offering two different funds made sense because the higher and lower parts of the credit spectrum attract different investors. The JAAA fund has a 30-day yield of 5.13%, and the JBBB fund has a 30-day yield of 7.25%. Invesco and VanEck also launched CLO ETFs last year, presenting additional investment options. When rates fall Floating rate debt can be a double-edged sword for investors. If the economy enters a recession and the Federal Reserve cuts rates, the funds could see their yields decline at the same time that investors are getting more skittish about holding corporate debt. That could create a "double whammy" for the lower-rated CLO funds, and is one reason why investors should be cautious in making these products a large piece of their fixed income portfolios, Armour said. However, there are diversification benefits to having floating rate ETFs for investors, especially in the U.S. where most fixed income products have a fixed rather than a floating rate, Kerschner said. Additionally, there is institutional demand for CLOs that can make these ETFs useful even when rates are falling, Laipply said. "I think generally there's demand for the space. As an example I know that insurance companies often have a dedicated allocation to highly rated CLO product. So we think there will be durable demand for this product over time," Laipply said.