Investors look for opportunities to generate returns and accumulate wealth with their assets. While stocks and real estate are two popular types of assets, some investors are looking into collateralized loan obligations, or CLOs. These assets reward investors when corporations make monthly loan payments.
CLOs tend to have higher yields than most stocks and corporate bonds, due to the underlying loans’ credit risk, and they’ve traditionally been the purview of big institutional investors. Over the long term, CLO tranches (groups of interest-paying bonds) have performed well overall compared with some other corporate debt categories.
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Fledgling collateralized loan obligation exchange-traded funds, or ETFs, have been taking off in recent years, making these sophisticated investments more accessible. The Janus Henderson AAA CLO ETF (ticker: JAAA), one of the “veteran” ETFs at nearly four years old, has $11.7 billion in net assets.
Firms like VanEck and BlackRock have also entered the industry and released their own CLO ETFs, launched in 2022 and 2023, respectively. Those funds have a combined $850 million in assets under management, or AUM, and feature high yields.
CLOs carry some risk, especially those focused on non-investment-grade borrowers. And tying money up in a fund that has lower assets and is less liquid can make it harder to sell that position to access the cash. ETFs are one way to diversify and bring risk down, but investors should always do their due diligence before hopping on investment trends.
That said, here’s a brief introduction to how collateralized loan obligations work, with some CLO ETF ideas to consider:
What Is a Collateralized Loan Obligation?
While collateralized loan obligation ETFs are new, the CLO as a financial instrument has been around for decades. According to S&P Global, “Collateralized loan obligations have performed well since their inception nearly 30 years ago and are a core asset class within structured finance, connecting investors around the globe with companies in the leveraged finance and private credit markets.”
Collateralized loan obligations reward investors as firms pay off their debt. These assets also cater to investors seeking portfolio diversification. Instead of relying on one company to make monthly loan payments, many CLOs give investors exposure to debt from more than 100 companies. Just as a stock ETF gives you exposure to many stocks, CLOs give you exposure to many corporate loans.
Collateralized Loan Obligation vs. Collateralized Debt Obligation
If collateralized loan obligations sound familiar, you may be thinking about collateralized debt obligations, or CDOs, an asset that was mentioned often in the 2015 film “The Big Short.” As explained in the movie, collateralized debt obligations inflated the housing bubble in the early 2000s and contributed to the Great Recession.
Can investors trust an asset like CDOs, and how do they differ from CLOs? Collateralized debt obligations are securities that contain individual loans and other CDOs. The issue with CDOs leading up to the Great Recession was that many of them included subprime mortgages. When borrowers couldn’t pay their subprime mortgages, many CDOs collapsed.
Collateralized loan obligations give investors exposure to leveraged loans. These loans are like high-yield bonds and get paid by large corporations. While CLOs rely on multibillion-dollar corporations to cover loan payments, some CDOs rely on consumers to cover mortgage payments. The latter faced struggles as subprime mortgage payments became unfeasible because the loan requirements attracted borrowers who couldn’t afford the monthly mortgage payments.
Owners of leveraged loans are paid out before bonds if a company goes bankrupt. The leveraged lender can receive appropriate assets to cover the loan’s balance before bondholders receive compensation.
CLOs have lower credit risk and typically have higher-quality borrowers than CDOs. These differences make CLOs more resilient to economic uncertainty than CDOs.
[READ: 10 Best Growth Stocks to Buy for 2024]
5 CLO ETFs That Reduce Risk
Collateralized loan obligation ETFs minimize the risk of traditional CLOs. While a CLO gives you exposure to more than 100 corporate loans in some cases, CLO ETFs give you exposure to several CLOs. Investors looking for high yields and reduced risk may want to consider investing in these five CLO ETFs:
VanEck CLO ETF (CLOI)
The VanEck CLO ETF invests in some of the top leveraged bonds. In addition, 65.7% of the fund’s assets are allocated toward AAA-grade and AA-grade CLOs. AAA is the highest possible grade for a CLO and indicates very little risk, while AA-grade also has minimal risk. Plus, 7.2% of the fund’s assets are in A-rated CLOs, and 9.1% are invested in BBB-rated CLOs. Finally, 18% of the fund’s CLOs are not rated.
CLOI has generated a 5.4% year-to-date return as of Aug. 22 based on its net asset value, or NAV, and it has a 0.4% expense ratio. The fund was launched on June 21, 2022, and it has around $440 million in net assets.
The average annualized yield to maturity for the ETF’s CLOs is 5.5%. It has a 12-month trailing yield of 6.2% and a 30-day SEC yield of 6.6%.
Alternative Access First Priority CLO Bond ETF (AAA)
The Alternative Access First Priority CLO Bond ETF has generated a 4.5% year-to-date NAV return as of Aug. 22 and has a 0.25% expense ratio. AAA has 45 holdings and has 49% of its total assets within its top 10 positions. The fund specializes in AAA-rated debt, with more than 93% of total assets in that category, while the rest is in cash.
Peter Coppa has been managing AAA since its inception on Sept. 9, 2020. Coppa has more than $1 million invested in the fund, according to Morningstar, which gives the ETF a five-star rating. AAA has a 30-day SEC yield of 6.4%.
The fund has 5.1% of its net assets in cash as of Aug. 22, and none of the top issuers get more than a 4.6% weighting in the portfolio.
Janus Henderson AAA CLO ETF (JAAA)
The Janus Henderson AAA CLO ETF has gained 4.8% in 2024 as of Aug. 22 and has a 0.21% expense ratio. The fund’s 30-day SEC yield currently stands at 6.7%. This fund prioritizes AAA-rated CLOs, which helped investors during the economic uncertainties of the financial crisis of 2007-2008 and the COVID-19 pandemic. The fund makes AAA-rated CLOs more accessible to retail investors.
Investors get to enjoy monthly cash distributions by holding onto shares of this ETF. Also rated five stars by Morningstar, the fund offers solid diversity with exposure to 367 holdings. None of the fund’s assets exceed a 1.7% concentration. The CLOs in this portfolio have a weighted average maturity of 4.7 years, and 53% of the fund’s debt matures within five years. JAAA uses the J.P. Morgan CLO AAA Index (CLOIE) as a benchmark and has been around since October 2020.
Janus Henderson B-BBB CLO ETF (JBBB)
The Janus Henderson B-BBB CLO ETF is for investors who want to incur more risk for a higher yield. BBB-rated debt is still likely to get paid, but AAA is the gold standard. JBBB has a 30-day SEC yield of 8.5% and has a 0.49% expense ratio. The fund uses the J.P. Morgan CLO BBB Index as its benchmark, and JBBB is up 6.3% in 2024 as of Aug. 22, making it the single best-performing CLO on this list. Just like JAAA, JBBB gives out monthly cash distributions.
The fund’s weighted average maturity is 6.4 years. About 59% of the fund’s holdings mature within five to seven years. JBBB has 97.2% of its assets in Baa-rated CLOs, and the remaining capital is distributed between A-rated debt, Ba-rated debt and cash.
Approximately 90% of the fund’s total assets are invested in North American debt. JBBB spreads its capital across 232 bond holdings.
BlackRock AAA CLO ETF (CLOA)
The BlackRock AAA CLO ETF offers the potential for higher income and lower volatility. The portfolio consists of mostly AAA-rated CLOs and uses CLOIE as its benchmark. The fund launched on Jan. 10, 2023, and offers monthly cash distributions. The 30-day SEC yield is currently 6.8%, and the fund has a 0.2% expense ratio.
The BlackRock AAA CLO ETF has 182 holdings. No holding makes up more than 1.3% of the fund’s total assets. CLOA’s CLOs have a weighted average maturity of 2.2 years with an average yield to maturity of 6.6%. Broken down, 54.4% of the fund’s debt matures within two to three years, and 12% of the fund’s debt matures within three to five years.
CLOA incorporates floating-rate debt to minimize losses during periods of rising interest rates. Interest rate hikes can also increase the fund’s cash distributions, but with the Federal Reserve poised to send rates down a quarter-point or two in September, investors may need to be patient in that regard. CLOA is up 4.8% this year through Aug. 22.
[See: 7 Best ETFs to Buy Now.]
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Collateralized Loan Obligations: 5 ETFs to Consider originally appeared on usnews.com
Update 08/23/24: This story was published at an earlier date and has been updated with new information.
