Panagram Structured Asset Management launched its actively managed collateralized loan obligations (CLOs) exchange-traded fund (ETF), opening the CLO asset class to a broader array of investors, including retail investors. The launch comes as corporate borrowers face an increasingly challenging credit and business environment.
Panagram joins a handful of asset managers that have created their own CLO ETFs in recent years. It started in September 2020, when Alternative Access Funds (AAF), an El Segundo, Calif.-based asset management firm, successfully launched the first one. Janus Henderson Investors quickly followed AAF in October 2020 with a CLO ETF that is required to invest at least 90% of its net assets in CLO bonds rated AAA or the equivalent. At the start of 2022, the asset manager launched the first CLO ETF to focus on CLO securities with less than stellar ratings, rated between single B-minus and BBB+.
Large asset managers BlackRock and Invesco took notice of where the market was headed, and they launched ETFs focused on investing in CLOs' AAA-rated bonds in January and December 2022, respectively.
As for Panagram, the New York City-based firm specializes in structured credit and manages $13.5 billion in assets, including a $5.6 billion fund that invests in the mezzanine portion of CLO deals. The credit range of the Panagram ETF's investments is a bit tighter than that of the Janus Henderson product, requiring that at least 80% of its CLO investments to have ratings between BB- and BBB+ and an initial offering size of at least $250 million.
Performance offsets cautionary note
CLOs invest in floating-rate leveraged loans, so they pose more of a credit risk to portfolios during tough times, like a rising interest rate environment or when borrowers face an increasingly challenging business environment. Yet leveraged loans enjoy higher repayment priority, and CLO structures insulate the deals from some of those risks. In fact, the bonds have performed exceedingly well since 2010, post-financial crisis, and even during the recent pandemic, said John Kim, CEO of Panagram. He noted that CLO bonds rated BBB by Standard & Poor's had zero defaults during that period, and registered just three among those rated BB.
"The number one factor behind the recent launches of CLO ETFs has been the performance of CLOs," Kim said. "When you look at their yields versus defaults compared to any other credit asset, investors are getting extraordinary risk-adjusted yield."
Kim also pointed to faster settlement of CLO transactions and more liquidity as signs that the market, initiated in the mid-1990s, has matured and now enables investors to better manage their positions. Another compelling draw for investors and other market participants, he said, is their liquidity in times of crisis. Throughout the pandemic and during the more recent U.K. gilt crisis they could sell their CLO positions if they needed to raise capital.
A few cautionary notes
Panagram has had plenty of positive incentives to create its product, but the current environment may raise investor concerns, according to Kim. One is that interest rates could peak in 2023 and start to fall, reducing returns on the floating rate investments. CLO credit spreads, however, provide a premium over comparably rated debt. Their yields might fall, but they should still remain attractive.
Aside from subordination and other structural elements that protect CLO investors, CLOs' focus on senior bank debt gives them priority when borrowers face financial difficulties, Kim said. The question is whether that dynamic will protect CLOs throughout the year, because default rates are anticipated to increase.
"When rates are rising so rapidly, it's unwise to think that no borrowers will be affected," Kim said, adding "there will be stress in the overall lending system, but there will be less stress in senior secured loans than high yield or mezzanine lending."
