CLOs – Diversifier, or another Equity Clone?

Investigating Collateralized Loan Obligations

November 2023. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Multiple collateralized loan obligation (CLO) ETFs have been launched since 2020
  • CLOs are promoted as low-risk fixed-income products
  • However, these simply represent diluted equity exposure and offer limited diversification benefits

INTRODUCTION

The U.S. leveraged loan market has increased from $100 billion in 2000 to $1.4 trillion in 2022, according to data from S&P Global, which is remarkable given that this period includes the global financial crisis in 2008 when many loans defaulted. The key role during that crisis was played by subprime mortgage debt that was promoted as low-risk securities via collateralized debt obligations (CDOs) to all types of investors.

Although CDOs have not had a major comeback, their cousin, namely collateralized loan obligations (CLOs), have become popular due to investors’ search for yield in the low-interest rate environment of the 2010s. Most of these loans are sourced from private equity firms that require financing for purchasing companies. The growth in the leveraged loan market mirrors that of the private equity industry, where the assets under management have increased to over $4 trillion (read Private Equity: Fooling Some People All the Time?).

Asset managers have capitalized on this demand by launching ETFs that offer access to CLOs to even retail investors. Recent issuers include Invesco, Janus Henderson, VanEck, PGIM, and BlackRock. However, given the poor track record of CDOs, investors might be wary of CLOs.

In the research article, we will evaluate CLOs.

UNIVERSE OF CLO ETFS

First, we review the universe of ETFs trading in the U.S. that offer exposure to CLOs, which amounts to eight products that were all launched over the last three years. The total assets under management are approximately $5 billion, but Janus Henderson’s AAA CLO ETF (JAAA) dominates this space with $4.4 billion. The management fees range from 0.19% to 0.50%, and the credit exposure varies from AAA to BBB.