Two years ago, the Federal Reserve’s rate-hiking campaign ushered in a wave of interest in CLOs. Sticky inflation and higher-for-longer rates drove investors to seek refuge in high-quality, floating-rate instruments like CLO AAA bonds. In fact, CLOs — bundled loans backed by pools of debt — have been the single largest source of demand for the more than $1 trillion institutional loan market.
The economic climate has since changed considerably. A cooler jobs market and tamer inflation have given the Fed breathing room to bring rates back down, and markets are pricing in two more cuts by year-end. Many CLO funds are now facing their first big test of resiliency, as investors ponder whether to stay in floating-rate products or rotate into fixed-rate bonds instead.
But so far, middle market leveraged loans continue to put on a strong showing. Providing multiple layers of risk exposure, CLOs have delivered the most attractive risk-adjusted returns in fixed income over the past decade. Even as rate cuts are poised to ramp up, CLO bulls believe the long end of the yield curve has already rallied in anticipation of those cuts. CLO ETFs still offer a compelling yield pickup compared to U.S. Treasuries and significant positive yield as inflation dips down toward 2%.
Additionally, a record near-$7 trillion has poured into money market funds. More investors are looking to stay in short-duration, money-market fund-like products, and CLOs offer another avenue. A blowout beat on September jobs and stronger retail spending have also increased confidence in a so-called soft landing, further bolstering the outlook for credit.
CLO ETFs Storm the Scene
While CLOs have existed for nearly four decades, CLO ETFs have only been around for four years. ETFs are making it easier for retail investors to access what’s traditionally been an institutional market (mainly banks and insurance companies) for the past 30-plus years.
There are currently 11 CLO ETFs on the market — with assets totaling just over $15 billion. AUM in the CLO ETF space jumped 40% in the first quarter of this year. The Janus Henderson CLO ETF (JAAA ) is still ten times bigger than any of its market peers — adding north of $8 billion this year alone — but there’s no question the universe is expanding. Most are focused on CLO AAA-rated bonds, but some managers may choose to reach further down the credit quality spectrum in exchange for higher yield.
CLO ETFs have seen a nearly five-fold increase in assets since 2023 as institutional and retail investors alike search for high-quality yield and diversification. Historically low defaults and attractive spreads have also increased investor appetite. Europe is also launching its first ever CLO ETF soon and BlackRock just filed for a new CLO ETF that targets BBB+ to B-.
Tomorrow, William Sokol, Director of Product Management at VanEck, will join me on VettaFi’s Q4 Fixed Income Symposium to make the case for why CLO ETFs remain compelling. Sokol manages both the $600 million VanEck CLO ETF (CLOI ) and the brand-new VanEck AA-BB CLO ETF (CLOB ).
CLOI charges 0.40% and invests predominantly in AAA- and AA-grade CLOs, with a smattering of assets parked in A- and BBB-rated CLOs. The fund has rallied nearly 7% on a total return basis this year. Meanwhile, CLOB invests primarily in AA- to BB-rated tranches of CLOs of any maturity, with an expense ratio of 0.45%.
The CLO market is small but fast-growing — attracting more attention from investors seeking floating-rate assets, attractive yields, strong credit fundamentals and appealing risk-adjusted returns. More and more advisors are seeking access to loans in a more liquid format, collateralized, pre-packaged loans are just a natural extension of investor’s search for yield.
For more news, information, and analysis, visit the Beyond Basic Beta Channel.
