Exchange-traded fund investors are venturing further into the fixed-income market amid moderating views on interest rates paired with an expected credit default cycle that hasn’t arrived.
Through June 11, ETFs holding harder-to-index securities like collateralized loan obligations, non-agency residential mortgage-backed securities, commercial mortgage-backed securities, and other asset-backed securities, have added $6.5 billion in net inflows, compared with $3.9 billion for all of 2023, according to data from CFRA Research.
Collectively, these securitized credit ETFs managed $13.5 billion, led by the $10.2 billion Janus Henderson AAA CLO ETF (JAAA), having taken in $4.8 billion since December.
Securitized credit ETFs are the Johnny-come-lately for fixed-income investors who spent the last decade acclimating to exposure to high-yield corporate debt and bank loans ETFs.
With $94 billion in aggregate assets under management across 79 distinct products, high-yield and loan ETFs are featured in a wide swath of investor portfolios, including insurance companies, university endowments, and state and provincial pension funds. Even with spreads historically tight for much of the high-yield and senior loan market, this mix of 61 passive and 18 active products has already added $9.9 billion in net inflows through June 11, compared with $6.6 billion for all of 2023, according to CFRA.
Spreads on securitizations, on the other hand, still have room for improvement, according to the May Janus Henderson Monthly Fixed Income Relative Value Report. AAA CLOs, for example, sat at a 139-basis-point spread to the secured overnight financing rate at the end of May, near the average of 145 and well within the historical range of 85 to 268 basis points.
“AAA CLOs have a large cushion from a safety standpoint,” said Vince Vitale, investment director at Advance Capital Management in Southfield, Mich., which manages $4.3 billion in client assets, including nearly 4 million shares of JAAA. Beyond brokers and financial intermediaries, specialty insurer Arch Capital Group, the State of New Jersey Common Pension Fund D, and Adventist Health System were all holders of JAAA as of March 31 filings with the U.S. Securities and Exchange Commission.
In CLO ETFs, investors get intraday liquidity and a boost in yield over traditional money market funds, currently between 6% and 7% for the ETFs holding investment-grade CLO tranches compared with just over 5% for the largest institutional money market funds.
The growth of the CLO market, passing $1 trillion in outstanding issuance for the first time since 2007, also provides a liquid alternative to the surging private credit market. While private credit fund investors have traded that liquidity for yields topping 10%, they’ve also sacrificed diversification, according to Bank of America Global Research.
Initiating coverage of CLO ETFs in April, BofA Securities Investment and ETF strategist Jared Woodard highlighted that CLOs are more diversified across sectors, with 44% exposure to its top five sectors compared with 60% exposure for private credit. That diversification and aggregation of mostly middle-market loans has also compelled the CLO complex to a cumulative 10-year default rate of just 1% compared with 11% for single-issue corporates, according to BofA.
"In the corporate market, we’re not getting paid for single issuer risk,” said Advance’s Vitale.
Ward Bortz, ETF portfolio manager and head of distribution for U.S. wealth at Angel Oak Capital Advisors, expects growth to accelerate for ETFs accessing securitized credit. Atlanta-based Angel Oak manages $17 billion in credit exposure across institutional funds, separately managed accounts, and nearly $1 billion in ETF assets.
Bortz points to the SEC’s 2019 ETF rule that, among other things, standardized the offering of actively managed ETFs with daily portfolio disclosure. This made it easier to bring to market a diversified credit product like the $205 million Angel Oak Income ETF, which can hold non-agency RMBS, ABS, CLOs and more. The ETF has added $100 million of net inflows since January, according to CFRA.
“Many of these securitizations are small issuances, and each securitization tends to be quite unique,” Bortz said. “They can’t really fit into a passive strategy.”
Of the 18 U.S.-listed securitized credit ETFs, 17 are actively managed.
The expected path of interest rates in the U.S. and the seeming soft landing for the economy has also spurred ETF investors back to riskier credits. The $919 million Janus Henderson B-BBB CLO ETF has added $776 million, or 85% of current assets, since December, according to the company. Its 30-day annualized yield was 8.36% as of May 31, according to Janus Henderson.
Other issuers in the CLO and securitized credit ETF market with products greater than $100 million in assets include BlackRock, VanEck, Panagram, PGIM and Invesco. Primarily built on floating-rate loans, these products offer little to no duration risk and less issuer and sector risk than ETFs holding single-issuer securities or loans.
John Kerschner, portfolio manager and head of U.S. securitized products at Janus Henderson Investors, believes that ETF investors who are just now wading into these products are likely to stick with them.
“They are instrumental in building robust fixed-income portfolios that offer excellent yields and are less affected by interest rate volatility,” Kerschner said.
