CLO ETFs Display Green Shoots After Tariff Dislocation

Inflows into CLO exchange traded funds, or ETFs, have picked back up after a volatile period in early April, when “in-kind” redemptions tested the structures amid the turmoil following President Donald Trump’s announcement of tariffs. Although flows have largely been positive in the months since, total assets held in these fund structures remain below their first-quarter peak.

According to Barclays Research, the CLO ETF sector saw outflows during the initial fallout from tariffs in April but have since seen steady inflows, including $663 million into triple-A ETFs during one week in May and $108 million inflows in the week of June 23.

After experiencing the swings in April, investors eyeing CLO ETFs are now cautiously awaiting the end of the 90-day pause on the implementation of tariffs by the end next week.

John Kerschner, head of U.S. securitized products at Janus Henderson, told Octus that his fund took in about $850 million in May, the vast majority of which was in-kind creates.

“Some days we’ll still get $100 million in in-kind redeems,” Kerschner said, adding that flows in June were strong but lower than the firm experienced in January and February. “The trend is a lot more creates than redeems,” he added. “I think that, overall, JAAA will continue to grow as the market settles down and people realize the investment thesis behind it.”

CLO ETFs such as Janus Henderson’s JAAA fund have historically offered high yields, but according to Stephen Anderberg at S&P Global Ratings, the asset class that first formed in 2020 took off when interest rates began to rise.

“JAAA’s yield now is in the high 5 [percent],” Anderberg said. “If you look at the history of this asset class, it didn’t do much until interest rates started to go up and then there was a lot of money that went into the space. So the growth in the asset class is going to be linked to what’s going on with rates.

Anderberg added that all of the CLO ETFs combined represent around 3% of the outstanding volume of CLO notes by dollar amount, but make up a larger portion of the buyer base for new CLO supply.

“If you do look at the flows, last year, 10% of the buying came from ETFs, so they are able to affect spreads even though they don’t yet represent a huge amount of the outstanding [volume].”

Dan Wohlberg, a CLO investor at Eagle Point Credit, said that triple-A CLOs make a good asset for an ETF due to their strong spread excess and relative liquidity during stress.

“CLO triple-As have historically been an incredibly good product for investors,” Wohlberg said. “They’ve had zero principal losses, they tend to offer excess spread above other similar floating rate instruments, and they tend to be very liquid in times of stress. That is obviously a very good baseline to build an ETF.”

However, ETFs that buy tranches further down the CLO capital stack seem like a riskier call to Wohlberg. Despite spreads returning to more normal levels after the dislocation from tariffs, Wohlberg said that the event proves that when CLO ETFs become forced sellers at the mezzanine level they can become an unpredictable market force.

Wohlberg said that the phenomenon can also happen with triple-A ETFs but is more pronounced further down the capital stack.

“CLO ETFs can exacerbate spread widening in the CLO market by adding a price-insensitive forced seller, causing prices to fall faster,” Wohlberg said. “A recent example would be pre-’Liberation Day’ CLO triple-A spreads, which were around 115 bps, but quickly widened into the mid-100s once tariffs were announced. That’s a pretty significant widening on a percentage basis.”

April marked the first time the CLO ETF asset class saw sustained outflows since its inception in 2020.

“One of the remarkable things about the asset class over five years was that we saw no net outflows over that period while seeing this exponential growth,” said Tom Schopflocher, analyst at S&P. “That changed briefly.”

One CLO investor said that during the initial tariff dislocation, their fund was able to buy a CLO tranche near redemption that they suspect came from an ETF’s forced sale. The investor suspected that the ETF sold the CLO at a discount despite its near redemption status because it was the highest-priced asset available for sale, allowing the investor to monetize the redemption with only settlement risk.

Kerschner said that while his funds saw outflows during the dislocation event, Janus Henderson’s ETFs have since returned to a more normal state and remain highly liquid.

“We knew something like this would happen; it’s not a surprise. What a lot of people were concerned about is CLO ETFs in general getting so large, particularly JAAA, and if you have some dislocation that would adversely affect the overall market,” Kerschner said. “It was the complete opposite. That’s not to say there weren’t redeems and withdrawals of JAAA.

“In very rough numbers the ETF got up to about $22 billion [assets under management] in March at the high water mark before getting down to about $20 billion in April, and now we’re back up to $21 billion,” Kerschner added. “So we’re not quite back up to the high water mark … but the CLO market itself and JAAA [are] liquidity ramped up, and trading increased by a whole lot.”

Kerschner said that when CLO ETFs are sold as cash alternatives, he stresses that investors must remain aware of short-term strain with a rapid bounce-back, as was the case in this scenario.

“There will be a drawdown. It should not be long, and it should not be that dire, but these things are gonna happen, and we’ve seen many times that it bounces back pretty quickly, and that’s what happened here,” Kerschner said.

Despite the assurances from CLO ETF managers, Wohlberg said that the reliability of these ETFs is questionable after April’s tariff volatility.

“Our view, as to the place of CLO ETFs, is that they certainly have a place in our market,” Wohlberg said. “We like the idea of the retail investor having access to the CLO market, and we think that CLO investments are resilient. However, when you consider CLO mezz tranches for ETFs, there is a pretty strong question as to whether or not ETFs are appropriate, due to liquidity constraints, as you could have undue losses in drawdown markets where these entities become forced sellers.”