Investors seeking yield as the Federal Reserve keeps rates higher for longer may want to consider exchange-traded funds that focus on collateralized loan obligations, according to Bank of America. The firm began coverage of this corner of the ETF space on Monday. Collateralized loan obligations are securitized pools of floating-rate loans to businesses, and they generate interest for investors. The underlying loans themselves can be made to non-investment grade borrowers, which is a risky bet. AAA-rated tranches are the least risky in the CLO world because they are first in line to get paid if a company goes bankrupt. “Loans sit atop of the capital stack with a 66% average recovery rate vs 44% for high yield bonds,” wrote Jared Woodard, investment and ETF strategist at Bank of America. Income-seeking investors dipping a toe into CLO ETFs will find that they get paid for taking on the additional risk: Yields can range from 6% to 9%, versus the 4% to 5% yield for investment grade bonds, Woodard added. Another benefit: The CLO space is looking attractive even as Fed Chair Jerome Powell has indicated that rates may need to stay high to get inflation back to the central bank’s 2% target. “CLOs hold floating-rate loans which has bolstered performance in a higher-for-longer rates backdrop,” Woodard wrote. “Despite yields near decade highs, CLOs still look cheap relative to corporate bond indices.” An ETF play Woodard’s team began coverage of one CLO fund: the Janus Henderson AAA CLO ETF (JAAA) . The fund has a 30-day SEC yield of 6.73% and a net expense ratio of 0.21%. JAAA has about 91.6% of its holdings in AAA-rated securities, and roughly 5.9% in AA-rated assets, according to the fund’s website. Year to date, the fund has attracted nearly $2.5 billion in new investment dollars, according to FactSet. “Among covered ETFs with higher credit quality, it has the highest yield,” Woodard said. “JAAA has an average correlation to fixed income and equity markets relative to CLO peers.” Other offerings in the space include the VanEck CLO ETF (CLOI) , which has an expense ratio of 0.40% and a 30-day SEC yield of 6.52%. There is also BlackRock’s AAA CLO ETF (CLOA) , an actively managed offering with an expense ratio of 0.20% and a 30-day SEC yield of 6.59%. Investors digging into the CLO ETF space shouldn’t just focus on yield, of course. Be fee-conscious as fund expenses can take a bite out of your returns. You should also be aware of the credit quality of the CLOs underlying the ETF and the additional risk these offerings face in an economic downturn. “Like most asset classes, volatility is a risk for loans and CLOs in times of extreme crisis,” said Woodard. “BB and BBB-rated CLOs witnessed close to 90% drawdowns during the [Great Financial Crisis] compared to 25% for loans.”
