By the Numbers
A boom in CLO ETFs is shaping parts of the market
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Even though CLO ETFs now hold only $11.4 billion in CLO debt or 1.3% of the outstanding broadly syndicated loan CLO total, the sector has nearly tripled in size in the last year. ETFs have consequently punched above their weight in the daily bid for CLO debt. In the short run, CLO ETFs should keep spreads on ‘AAA’ classes tight. In the long run, the parts of the market likely to get the biggest lift include longer ‘AAA’ tranches, junior ‘AAA’ tranches and the debt of managers trading at wide spreads.
Although CLO ETFs have been around since Hartford launched in May 2018, the launch of the Janus Henderson AAA CLO ETF in March 2022 changed the market. That fund has quickly grown to $9.4 billion in assets or 84% of the CLO ETF total (Exhibit 1). The Janus Henderson B-BBB CLO ETF holds $588 million or 5%. But that is just the beginning.
Exhibit 1: Outstanding CLO ETFs
Source: Bloomberg, Santander US Capital Markets
CLO ETFs have grown extremely quickly in recent years (Exhibit 2). Since the Janus ‘AAA’ fund launched, CLO ETF balances have grown at a compounded annual rate of 202%. In the last year, CLO ETFs added $8.37 billion in AUM, growing by 279%.
Exhibit 2: CLO ETFs have grown rapidly in recent years
Source: Bloomberg, Santander US Capital Markets
The growth is more than just demand for floating-rate debt. Money market mutual funds, the safest form of floating-rate debt, have grown only 23% in the last year. Leveraged loan ETFs, a form of risky floating-rate debt, have also lagged CLO ETFs. The benchmark Invesco Senior Loan ETF, better known as BKLN, has grown in the last year by 112%, faster than money market funds but less than half the pace of the CLO ETF market (Exhibit 3).
Exhibit 3: Growth in CLO ETFs has outstripped the benchmark loan fund
Source: Bloomberg, Santander US Capital Markets
If the constraints on the Janus ‘AAA’ fund are good indication of the broader sector, then a few are worth noting:
- The fund invests at least 90% of its net assets in CLOs rated ‘AAA’ at time of purchase
- The fund can invest remaining assets in CLOs with a minimum rating of ‘A-‘ at time of purchase
- The fund will not invest more than 5% of its portfolio in any single CLO, and no more than 15% in CLOs managed by a single CLO manager
These constraints seem likely to encourage the ETF market to lean in a few directions:
- Toward longer ‘AAA’ tranches, which trade a wider spreads than shorter tranches
- Toward junior ‘AAA’ tranches, which trade wide to senior ‘AAA’ but still meet fund requirements
- Toward a diverse set of managers
Casual review of the Janus ‘AAA’ fund holdings suggests the fund is leaning in these directions, which implies that continued growth should keep these parts of the CLO market better bid than others. The requirement to diversify across managers should generally reduce spread dispersion across managers, too, especially helping the spreads of managers that tend to trade wide.
Even if CLO ETF growth drops well off its recent pace of doubling or tripling every year, it still stands to create important marginal demand for eligible tranches. New ‘AAA’ debt should remain well bid and along with junior ‘AAA’ and the debt of managers that help funds diversify. As long as CLO ETF growth continues, these sectors of the market should outperform.
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