In a search for meaningful yields, investors are turning to collateralized loan obligations (CLOs), particularly amid traditional market uncertainty. These floating-rate loan instruments have drawn over $25.6 billion into CLO and bank loan ETFs, signaling a shift in investment trends. However, the heavy focus on AAA-rated CLOs may be limiting potential gains.
While AAA tranches offer security, VanEck and others argue investors should also explore investment-grade tranches rated BBB- or higher. Historically, A-rated CLOs outperformed AAA by 142 basis points annually, while BBB-rated CLOs outpaced AAA by 147 basis points, with less volatility than corporate bonds. CLOs’ shorter durations also help reduce interest rate sensitivity—an appealing trait in today’s climate.
Despite the popularity of funds like Janus Henderson’s AAA CLO ETF (JAAA) with $22 billion in assets and a 5.37% yield, the space is becoming saturated. New ETFs like JBBB (targeting B-BBB tranches) and VanEck’s CLOI offer diversified CLO exposure, encouraging investors to broaden their horizons.
The launch of VanEck’s CLOB ETF, focused on AA to BB-rated CLOs, adds further opportunity, with a 6.6% yield. Though lower-rated tranches carry more risk, the economic backdrop remains relatively stable. Active management and security selection, emphasizing manager quality and underlying assets, are crucial to navigating this complex landscape.
In a volatile market, staying confined to AAA ratings may limit returns. As CLO offerings expand, investors must assess the risk-reward tradeoff and consider that opportunity often lies just outside their comfort zone.
