Investors Eye AAA CLO ETFs as $8T Sits in Cash

About $8 trillion was held in money market funds at the end of the first quarter, prompting advisors and investors to look for fixed-income alternatives that avoid equity exposure.

One option gaining attention is ETFs that target AAA tranches of collateralized loan obligations. Fidelity launched two such ETFs, the actively managed Fidelity AAA CLO ETF (FAAA) and the Fidelity CLO ETF (FCLO), in February. Both funds began with fee waivers for their first 12 months.

AAA tranches are the highest-rated slices of CLOs, which pool senior secured corporate loans and divide them into rated classes. Those top slices sit at the front of the payment hierarchy and are designed to absorb the least credit loss.

Fidelity’s commentary cited historical performance: AAA-rated CLOs produced positive monthly returns in about 88% of months since late 2011. The benchmark JP Morgan US CLOIE AAA Index averaged roughly 3.4% per year over that period, Fidelity noted.

Fidelity wrote in its sector commentary, “Bonds-particularly core and limited-term strategies-offer an alternative that can balance income potential, risk management, and portfolio resilience. And there’s an even more conservative option, AAA CLOs, which have meaningfully topped the performance of money markets, on average, since late 2011.”

Portfolio managers and product sponsors also highlight an attractive yield relative to duration as a technical benefit of AAA CLO ETFs versus some other fixed-income options. The ETF structure can provide daily liquidity for investors who do not want to buy individual CLO tranches.

Some of the money market balances represent institutional dry powder or required reserves for fund managers. With cash yields declining and the Federal Reserve unlikely to cut interest rates this year, advisors report that a portion of that capital is being evaluated for alternatives that seek higher income while aiming to preserve capital.

Regulatory differences and the liquidity of the underlying loans remain considerations for investors. Recent ETF launches and the available historical return data have contributed to growing interest in AAA-rated CLO ETFs among investors reassessing large cash holdings.