These 3 CLO ETFs Target a Niche Corner of the Fixed-Income Market

June 12: Elon Musk’s “Day-One Retirement Plan.” (From Brownstone Research)

Collateralized loan obligations (CLOs) are securitized portfolios of corporate loans divided into tranches by risk profile. For many retail investors, CLOs can be foreign and uncomfortable, but the potential for attractive yields, floating-rate income, and diversification is strong. Some investors may also not be aware of how easy it can be to build CLO exposure into a portfolio with dedicated exchange-traded funds (ETFs).

ETFs already offer a diversification benefit for many fixed-income investors, helping to reduce issuer-specific, sector-specific, or credit-event risk compared with owning individual securities. Because they trade throughout the day like stocks, ETFs are also easy for investors to buy into or sell out of if they need to make portfolio adjustments in real time.

That ETF structure matters because CLO investing is not one-size-fits-all. CLO ETFs are not just easier access to a once-institutional credit market; they also offer the ability for investors to choose where they want to sit on the risk spectrum, from AAA-rated CLO exposure to higher-yield BBB and BB tranches. Funds such as the Janus Henderson AAA CLO ETF (NYSEARCA: JAAA), the Eldridge BBB-B CLO ETF (NYSEARCA: CLOZ), and the iShares AAA CLO Active ETF (NASDAQ: CLOA) may all invest in CLOs, but they offer very different combinations of credit quality, yield, liquidity, and risk.

JAAA: A Fund Targeting the Highest-Quality CLOs Available

The Janus Henderson AAA CLO ETF is focused on AAA-rated CLO tranches, the highest-quality slice of the CLO capital structure.

These securities generally receive payments before lower-rated tranches, which helps explain why AAA CLO debt has built a strong historical credit record through multiple market cycles.

For investors concerned about risk, JAAA offers a more conservative way to access CLO income than funds focused on lower-rated tranches, though it still carries credit, liquidity, and interest-rate risk.

AAA-rated CLO tranches have historically shown lower volatility and lower downgrade risk than lower-rated CLO debt. JAAA offers retail investors access to a part of the CLO market that has traditionally been dominated by institutional buyers.

Investors in JAAA will likely appreciate that despite being actively managed, the fund has a low expense ratio of 0.20%. It also has strong liquidity for a niche credit ETF, with more than $27 billion in managed assets and a narrow 30-day median bid-ask spread. Because liquidity can be a concern with CLOs, JAAA’s scale and trading profile may help to ease investor worries in that regard.

Investors seek CLOs for their cash distributions, and JAAA offers a compelling yield of 5.%. Its portfolio of more than 600 AAA-rated CLOs enjoys low correlation to other fixed-income classes as well, providing helpful diversification for income-focused investors.

CLOZ: High Yield While Protecting Against Default

While JAAA seeks the highest-quality CLO tranches, the Eldridge BBB-B CLO ETF targets CLOs rated BBB or BB.

These lower-rated tranches tend to come with greater credit risk and price volatility, but they also offer the potential for greater income than AAA-rated CLO exposure.

CLOZ is also an actively managed fund, so it carries a higher expense ratio than JAAA. Investors pay 0.50% annually for access to CLOZ's portfolio of more than 160 CLOs. Like the AAA-rated CLOs in JAAA's basket, CLOZ offers investors a set of products that have low correlation to both stocks and traditional fixed-income investments. Because CLOZ groups together a range of CLOs from different issuers and industries, this helps to further reduce single-issuer and single-deal risk.

While CLOs generally have low default risk, lower-rated CLO tranches are more exposed if loan defaults rise or credit conditions weaken. But in exchange for taking on a bit more risk, investors are rewarded with a yield of 7.4%, making CLOZ an excellent source of passive income with a unique focus and profile compared to many other bond funds.

It should be noted, though, that CLOZ is a much smaller fund than JAAA—it has under $700 million in managed assets and a one-month average trading volume just over 250,000—and so liquidity may be more of a concern in this case, especially during periods of credit-market stress.

CLOA: A Smaller Rival to JAAA

Another AAA-focused fund, the iShares AAA CLO Active ETFfocuses on U.S. dollar-denominated, AAA-rated CLOs.

The fund competes most directly with JAAA on credit quality and cost: both ETFs focus on AAA-rated CLO exposure and carry a 0.20% expense ratio.

For that fee, CLOA investors receive a portfolio of more than 400 holdings, giving them another low-cost way to access the highest-rated segment of the CLO market.

The main difference is scale, as CLOA is smaller and less liquid than JAAA but still offers a focused, actively managed approach to AAA CLO exposure. The fund has more than $2 billion in managed assets and a one-month average trading volume of around 415,000. However, its yield of 5% is roughly on par with its larger rival.

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