Esoteric credit products like CDOs and CLOs gained mainstream notoriety ten years ago as politicians, pundits and a deeply humbled Wall Street accused them of helping to nearly destroy the global economy. But a few years ago, banks started looking for new ways to package and sell “safe” high-rated CLOs and other products based on the newly ascendant leveraged loans.
Now, it seems, lenders are facing a perfect storm: With the Fed making a foray into the corporate credit market, part of the central bank’s quest to make investing losses a thing of the past (at least for now – or for as long as it can) and Robinhood-enabled retail traders buy up tech stocks, bitcoin, gold (or at least the precious metals ETFs that offer ‘easy exposure’ to gold and silver), ETF sponsors are quickly dreaming up new products to hawk to this newly invigorated generation of retail
bagholders traders who understand only one thing about market dynamics: Prices simply don’t go down.
And with brokerages now relying on bundling retail trades and selling ‘order flow’ to the big HFT firms – all of Robinhood’s established competitors have now adopted this business model as commissions have gone out of fashion – there’s a new perverse incentive to create products that will encourage mom-and-pop traders to play in markets previously reserved for institutional traders. And the latest example of this comes via Janus Henderson, the $337 billion asset manager that just filed to launch a new ETF that will allow Robinhood traders to buy into the highest-quality AAA-rated CLOs.
At a time of mounting corporate defaults and deepening economic gloom, a new fund may be about to bring collateralized loan obligations to the masses.
Janus Henderson is planning a U.S. exchange-traded fund that will seek floating-rate exposure to the highest-quality CLOs, according to a filing with the Securities and Exchange Commission this week. While many loan ETFs exist, there are currently none dedicated to CLOs.
CLOs, which package and sell leveraged loans into chunks of varying risk and return, have drawn scrutiny in recent months as the coronavirus pandemic spurs a wave of corporate distress. They typically don’t attract retail investors, though an ETF would in theory make them far more accessible.
Wary day traders can rest assured: because the loans comprising these CLOs are among the safest and most highly rated on the market.
The riskiest corners of the $700 billion CLO market may be signaling trouble, but the highest-rated tier tends to be a safe space, he said.
“In the case of AAA CLOs, it’s a safe and low-risk asset class,” said the chief investment officer. “Yields are fairly low on AAA CLOs in the first place, but if investors can earn 150 to 175 basis points of spread on a short duration asset, it can be attractive.”
And with the Fed bent on keeping rates low until things get “back to normal”, this might be only the beginning.
The central bank’s intent to keep them low for the foreseeable future could mean the more-than $4 trillion U.S. ETF market sees a spate of launches like the fund planned by Janus Henderson, according to Ken Monahan at Greenwich Associates.
“Given that yield suppression is here to stay it would seem, you’ll probably see a lot more of this,” said the senior analyst covering market structure and technology. “RMBS and CMBS are probably not far off.”
CLOs are a cousin of collateralized debt obligations, which became notorious for their starring role in the 2008 financial crisis.
There are several major differences, however, not least that CDOs bundle loans to consumers rather than businesses.
But once the Fed backstop is removed – if that ever happens – the only real beneficiaries of this product will be the fund sponsors who collect the management fees, and the HFT firms who front-run the order flow in the underlying CLOs.