The CLO ETF market has advanced swiftly, growing to about $30bn since its inception in the US in 2020.
Where the US has led, Europe has eventually followed. The first European CLO ETF — the Fair Oaks AAA CLO ETF — was launched a year ago.
The ETFs invest principally in triple-A rated CLO notes.
Most CLO ETFs are actively managed and use one of JP Morgan’s CLO indices as a benchmark, partially mirroring the index and trying to beat or match its performance.
The impact of CLO ETFs has so far been broadly positive, granting access to CLOs to smaller investors and generating extra liquidity in the underlying product.
But the liquidity of the very CLOs in which these ETFs invest could slow their growth.
Many CLO ETFs aim to offer daily liquidity to their investors, buying and selling positions in quickly while tracking an index.
Triple-A rated CLO tranches are relatively liquid, as there is an active secondary market. Nonetheless, it is not always sufficiently liquid to match the needs of an ETF, especially given that large investors like banks sometimes buy and hold entire tranches.
This is not a problem for ETFs with their current share of the CLO market, which S&P estimates is 3% in the US. However, were CLO ETFs to represent a large share of CLO investors, they could not, in simple terms, all sell liabilities at the same time.
There may also be a limit to the number of CLO ETFs that can be scaled up successfully. Illustrating the point, the $21bn Janus Henderson AAA CLO ETF constitutes 70% of the US CLO ETF market.
Like many funds, CLO ETFs have expenses such as regulatory, reporting, trustee and trading costs.
Some of these costs are fixed and can be borne on the broad shoulders of a larger fund. But they can affect the viability of smaller funds.
Larger funds are also taken seriously by CLOs, giving them the muscle to buy and sell investments at the speed the ETF model demands.
CLO ETFs have plenty of headroom to grow, but there are some natural constraints on their final size and number.