As a long-time reader, you may know that I have been bullish on CLO ETFs for over a year. This is due to the strong and growing dividends and the comparatively stable share prices that these funds offer. I’m bullish on most of these ETFs, but here is a focus on the following three:
Fund Filings – Table by Author
When discussing these and other variable rate funds, I sometimes get asked about potential Fed rate cuts. Although these would result in lower dividends for most CLO ETFs, I’m still quite bullish on these funds for three main reasons.
First, these ETFs offer strong yields right now, and so are fantastic short-term investments.
Second, these ETFs should continue to offer strong, above-average yields for a couple of years, as per Fed guidance.
Third, these are generally safe and low-risk investments with little credit or interest rate risk. The latter is of particular importance right now, with interest rates in flux.
Due to the above, I believe that CLO ETFs remain strong investment opportunities even as the Federal Reserve seems poised to cut rates.
CLOs – Quick Overview
As CLOs are something of a niche asset class, it is a good idea to have a quick explanation of how these work before analyzing the funds themselves. Feel free to skip this section if you already know all about CLOs or have read my prior articles on the subject.
* Senior secured loans are floating-rate loans from banks to medium-sized, riskier companies.
* These loans are senior to other debt and secured by company assets.
* Senior loans are sometimes bundled together in CLOs.
* Each CLO, or bundle of senior loans, is divided into tranches.
* Income from the senior loans is used to make payments to all tranches.
* Senior tranches get paid first; junior tranches get paid last.
* CLO tranches are generally variable rate instruments, whose coupon rates fluctuate with Fed rates.
* Investors can buy into these tranches and receive income from the bundle of senior loans.
CLO ETFs – Overview
Different ETFs focus on different tranches. Here is a closer look at three specific ETFs:
* The Janus Henderson AAA CLO ETF (JAAA) focuses on AAA-rated tranches. These get paid first, and so are incredibly safe and high-quality investments. As per S&P, not a single AAA-rated CLO has ever defaulted, and these securities have existed for several decades.
* The Janus Henderson B-BBB CLO ETF (JBBB) focuses on BBB-rated tranches. These get paid sometime after AAA-rated tranches, and so are a bit riskier. If senior loan default rates increase, payments for AAA-rated tranches will be prioritized, and perhaps there will be nothing left for BBB investors. In practice this rarely occurs, with default rates for these tranches in the 0.01% – 0.10% range.
* The Panagram Bbb-B Clo ETF (CLOZ) focuses on BBB and BB-rated tranches. Risks are somewhat higher than for JBBB, but not significantly so.
CLO ETFs – Reasons to Buy
Strong Present Yields
CLO ETFs offer strong yields right now, and so are fantastic short-term investments. For the more risk-averse investors, JAAA’s 6.3% dividend yield is quite good, and higher than most other investment-grade bond sub-asset classes, including t-bills, treasuries, MBS, and corporate bonds.
Both JBBB’s 7.8% dividend yield and CLOZ’s 9.4% yield are higher than that of BBB-rated fixed-rate bonds and have much higher credit risk.
For short-term investors, CLO ETFs offer some of the highest yields on the market, quite a bit higher than average.
Competitive Medium-Term Yields
Current Fed guidance is for three cuts in 2024, another three in 2025, and a long-term rate of 2.5%. For reference, current Fed rates are at 5.25% – 5.50%.
Under current Fed guidance, CLO ETF yields would remain competitive for a few years.
* JAAA’s 6.3% dividend yield would remain higher than that of 10y treasuries until 2027, and would settle on being 0.20% – 0.50% lower.
* JBBB’s 7.8% dividend yield would remain higher than BBB-rated fixed-rate bonds until 2026-2027, and would settle on being 0.50% – 0.70% lower.
* CLOZ’s 9.4% dividend yield would remain higher than fixed-rate investment-grade bonds for the foreseeable future, and higher than high-yield bonds until 2027.
Comparatively Low-Risk Investments
CLO ETFs have comparatively low credit risk, interest rate risk, volatility, and drawdowns.
Conclusion – CLO ETFs are a Buy
CLO ETFs offer investors above-average yields at below-average risk, and are a buy.
