ETFs
Investors poured $1.6 billion into bank loan ETFs and CLOs in June: State Street
Investors ramped up their risk appetite in bonds in June, seeking higher yield as Federal Reserve policy remains uncertain, according to State Street data. Fixed-income exchange-traded funds saw nearly $25 billion in flows last month, with investors adding more than $6 billion to their exposure to long-term government bonds, the asset manager found. However, investors also added more than $1.6 billion to credit risk, directing more than $1.6 billion to ETFs with underlying bank loans and collateralized loan obligations, State Street found. “These funds have now seen 13 consecutive months of inflows, taking in more than $18 billion during that period, as investors seek exposures with limited rate volatility amid elevated rate risks from monetary policy moves,” Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, wrote in a report last week. Chasing Yield Bank loans and CLOs are bets on the current higher interest rate environment. Large institutional investors can buy bank loans (which lending institutions make to companies) and benefit from the floating rate coupons on those loans. Those coupons offer attractive yields as long as rates remain high. Bank loans are typically below investment grade, but they are secured by the borrower’s assets, which typically means the lender is first in line to get paid if the borrower goes bankrupt. CLOs are similar to bank loans: They are pools of floating-rate loans to companies that may be below investment grade. The CLO itself is comprised of tranches that each have their own corresponding risk characteristics. The highest-rated CLOs (those deemed AAA by rating agencies) are the first to be paid out if a borrower goes bankrupt. While the floating-rate component of these assets allows them to perform well in a rising rate environment, investors could see their returns diminish once the Fed begins to taper. Individual investors cannot afford to own bank loans and CLOs, but they can gain exposure to the space through ETFs. While these strategies should not make up the lion’s share of an investor’s bond allocation, they can be a small component of a diversified portfolio. For example, the BlackRock Floating Rate Loan ETF (BRLN) has an expense ratio of 0.55% and a 30-day SEC yield of more than 8%. In the CLO space, the Janus Henderson AAA CLO ETF (JAAA) has become a popular choice with nearly $5.4 billion in flows in 2024, according to FactSet. It has an expense ratio of 0.21% and a 30-day SEC yield of 6.6%. Know Your Risk Investors’ search for yield is happening at a time when the economy is strong, earnings are rising and ratings momentum is improving, Bartolini told CNBC in an interview. “We finally have more upgrades now versus downgrades on high-yield and investment-grade bonds.” » He also noted that while investors may view bank loans and CLOs as inherently risky because of their exposure to lower-than-investment-grade borrowers, they should keep an eye on the risk of rate volatility elsewhere in their portfolios as long as Fed policy remains uncertain. Bank loans and CLOs tend to be less sensitive to rate changes, meaning they have short lives. Fixed-income assets with longer maturity dates tend to have longer durations and may be more susceptible to price action when rates change. “Rate volatility is one of the biggest risks in the bond portfolio right now,” Bartolini said. “Rate policy is changing and uncertain, and it’s unlikely to be any less murky as we head into the summer months.”