Corporate credit manager Fair Oaks Capital won the race to launch Europe’s first collateralised loan obligation (CLO) ETF last week and fund selectors are already “keen to investigate” the specialist exposure.
The Fair Oaks AAA CLO UCITS ETF (FAAA) will list on the Deutsche Boerse and London Stock Exchange as an ETF share class of an existing Luxembourg-domiciled mutual fund, the Fair Oaks AAA CLO fund, which houses €161m assets under management (AUM).
FAAA captures euro-denominated AAA-rated CLOs, which are bundles of non-investment grade loans, often first lien bank loans to businesses or private equity borrowers, which are grouped into tranches of 150 to 250 loans by CLO managers and sold to investors.
The ETF’s launch sets a precedent for the exposure being available to European investors, with no 100% CLO fund having been approved and no US CLO issuance being deemed UCITS eligible since 2019.
Such regulatory barriers – and divergence between Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF) and the Central Bank of Ireland (CBI) – have posed challenges to other potential CLO ETF hopefuls including Janus Henderson and VanEck.
CLOs in the crosshairs
The arrival of CLO ETFs in Europe could offer an attractive proposition for some investors, offering relatively high yields while capturing only high-rated issuance.
In the US, for instance, AAA-rated CLO issuance such as that captured by FAAA is a popular allocation among institutional investors and banks constrained by certain capital rules.
Miguel Ramos Fuentenebro, co-founder and partner of Fair Oaks, commented: "FAAA offers investors liquid exposure to a diverse pool of AAA-rated floating-rate assets, which have a superb track record of no defaults since the first AAA-rated CLO was issued over 25 years ago.
"Our core belief is that the CLO market generates consistent, repeatable, and superior risk-adjusted returns over multiple market cycles versus other credit strategies."
Nathan Sweeney, CIO at Marlborough, noted FAAA provides liquid exposure to a diverse pool of CLOs, a feature “missing” from traditional CLO investments.
“As a fund selector, I am excited about the launch of FAAA, a compelling development in the fixed income space,” Sweeney said.
“The product's strong track record of AAA CLOs — with no defaults in over 25 years — installs confidence in its ability to deliver attractive, risk-adjusted returns in a floating-rate format. Following the news, we will be keen to investigate further.”
Not all are enthused
However, while noting “scope for a huge amount of innovation” within the credit ETF space, Goncalo Machado, investment manager at InvestEngine, said the “complex nature” of CLOs means they will be hard to market and allocate to on behalf of less sophisticated end clients.
He added: “With the risk-free rate where it is, despite any incoming interest rate cuts, I do not believe the risk-reward is present at the moment.”
Also, while CLOs are distinct from the collateralised debt obligations (CDOs) and ‘bespoke tranche opportunities’ at the heart of the Global Financial Crisis (GFC), it appears Fair Oaks and those that follow will have to overcome the cultural hurdle of guilt by association in order to increase investor and regulator confidence in the exposure.
“Let us also not forget the ghosts from 2008 which will haunt any product of this nature going forward,” Machado concluded.
