Reckoner: Retail ETFs Drive CLO Market Comeback

At a Q2 Market Outlook Symposium, Reckoner Capital and TMX VettaFi described retail investors as a key source of recent inflows into the collateralized loan obligation market after CLO exchange-traded funds recorded about $6 billion in net inflows so far this year.

John Kim, chief executive of Reckoner Capital, and Kirsten Chang, senior industry analyst at TMX VettaFi, discussed how ETF wrappers have broadened access to CLO tranches that were previously held mainly by institutional managers.

Kim raised an often-asked concern from investors, asking whether people still view CLOs as the products that “blew up” in past crises. He pointed to market research showing that AAA CLO tranches have recorded no defaults over the past 30 years and that BBB-rated mezzanine tranches have not recorded defaults over the past 15 years.

Panelists identified two main drivers of the ETF inflows: greater product accessibility and demand for floating-rate income. Many CLO tranches pay floating coupons, which can provide rising income when interest rates increase compared with fixed-rate corporate debt.

Reckoner cited two of its funds as examples: an ETF that targets AAA tranches and uses a leverage feature to seek higher yield, and an ETF that focuses on BBB-B mezzanine tranches for higher potential income. The firm also offers reinvesting versions that retain and automatically reinvest returns to reduce 1099 dividend income for shareholders.

A symposium poll found most financial advisers and investors currently allocate no capital or only a small satellite position to structured credit. Panelists said further education is needed so advisers can assess where CLO exposure might fit within a fixed-income sleeve.

Speakers listed risks for investors to consider. CLOs are structured products backed primarily by below-investment-grade corporate loans. Funds that hold CLO securities can be exposed to management risk, novel-structure risk, leverage risk, liquidity risk and concentration risk. ETFs can trade at premiums or discounts to net asset value. Past performance does not guarantee future results.

Collateralized loan obligations group corporate loans into pools and issue tranches with different seniority and coupon characteristics. Senior tranches receive greater credit protection and typically lower yields, while mezzanine tranches carry higher credit risk and higher yields. Recent ETF flows have made tranche exposure accessible to retail investors through publicly traded funds.