Fixed income ETFs appear primed for disruption with Janus Henderson tipped to bring their flagship collateralised loan obligation (CLO) ETF to Europe, however, the US giant may not be the only horse in the race to be first to market with the exposure.
Speculation surrounding a UCITS re-run of the Janus Henderson AAA CLO ETF (JAAA) began last month after the asset manager acquired fixed income ETF specialist Tabula Investment Management.
Fund selectors reacted to the deal with predictions the firm would look to target Europe’s under-cultivated active ETF market.
“Active bond ETFs have more room to grow than just more ‘exotic’ equity products,” Goncalo Machado, investment manager at InvestEngine, said.
“With the way most fixed income ETFs have been built so far, there is scope for a huge amount of innovation given the current credit environments.”
A source close to Janus Henderson has since confirmed the manager is looking to launch a CLO ETF in Europe.
However, the new arrival to European ETFs could have its debut launch upset as VanEck is also looking to launch a UCITS iteration of its US-listed CLO strategy, a source close to the firm told ETF Stream.
VanEck declined to comment.
The road to Europe’s first CLO will not be a straightforward one, though, as regulatory obstacles remain firmly in place.
Michael John Lytle, CEO of Tabula, told ETF Stream ESMA, Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF) and the Central Bank of Ireland (CBI) “brought the door down” on funds providing dedicated exposure to CLOs.
“When launching a CLO ETF, the biggest challenge is clearly regulatory, because no 100% CLO fund has been approved since 2019,” Lytle said.
While some funds launched before 2019 have been grandfathered to have a 100% CLO exposure threshold and subsequent launches can allocate up to 35% to the asset class, Lytle said he has “no idea” if or when the CBI would approve dedicated CLO UCITS ETFs.
An added complexity is CLOs issued in the US since January 2019 are also UCITS ineligible, effectively meaning US CLOs cannot be included within a UCITS ETF.
This means an iteration of JAAA – now a $10bn ETF – would have to be adapted to capture European CLOs to comply with UCITS rules in their current form.
“The European CLO market has grown a lot in the last decade,” Lytle said. “It is a pretty healthy $230bn of outstanding issuance and the AAA market is very robust and liquid.”
One factor working in Janus Henderson’s favour is they do not have to wait for final Financial Conduct Authority (FCA) approval of the Tabula acquisition to begin filing a CLO ETF.
“We have done products with Haitong, partner products with JP Morgan and BAML in the past,” Lytle said.
“There is nothing about the M&A transaction that impacts our ability to launch products with Janus Henderson. Even if Janus Henderson had not decided to buy the company, we would have happily launched a product with the firm because it is a great company with fantastic IP.”
Similarly, ETF Stream understands VanEck faces the same challenges in getting their ETF approved by the CBI, but their strategy contains some distinctions versus JAAA.
For instance, while both ETFs are actively managed, the $364m VanEck CLO ETF (CLOI) is sub-advised by an external specialist manager – PineBridge Investments – and moves further down the credit rating spectrum to enhance yield.
While this means CLOI currently boasts a 42-basis point (bps) yield advantage over JAAA’s 6.39% 12-month yield, as at 3 June, a basket containing lower-related loans may give regulators additional pause for thought.
If VanEck were to consider a AAA-rated CLO ETF in UCITS format, this would mean taking time to develop a new strategy, lowering its odds of being first to market, with more niche exposures tending to have a ‘winner takes all’ dynamic to asset gathering.
AAA-rated exposure is also more suited to institutional investors and banks constrained by certain capital rules, whereas wealth managers may seek additional yield by moving down the credit spectrum.
Overall, the broadest headwind issuers will face is getting the European market – regulators, investors and even their own teams – comfortable with the idea of wrapping CLOs within ETFs.
The unique instruments 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.
For some, this will conjure memories of the CDOs and ‘bespoke tranche opportunities’ at the centre of the Global Financial Crisis (GFC), but the key difference is CDOs are comprised of mortgage pools, whereas CLOs are backed by corporate credit with a leverage factor of no more than 6x.
CLO ETFs including JAAA also touch on a number a key points for investors, boasting strong liquidity, 192bps of yield spread versus 10-year US Treasuries, minimal effective duration of 0.27 years and low default risk, with no tranche of AAA-rated CLOs ever having defaulted.
The questions to address now are whether Janus Henderson will be able to recreate the 95% CLO market share dominance it has achieved in the US here in Europe, whether there will be more demand from European or Latin American and APAC investors for UCITS iterations of the products and whether regulators will approve the products in the first place.
