Bailey McCann writes from New York that new regulatory allowances and low yields in fixed income is driving US investors into riskier credits and they’re doing it in a new breed of ETFs.
Low yields, rising (if transitory) inflation, and policy uncertainty are making it difficult for fixed-income investors to get much out of a traditional bond portfolio. In an effort to find yield, investors of all types are considering riskier parts of the fixed income universe because they offer higher yield potential. Fallen angels, bank loans, and even CLOs are getting a closer look.
Historically, these asset classes have been the domain of institutional investors and high-priced money managers. But recent regulatory shifts have opened the door to offering exposure through ETFs and many firms are rushing to stake out market share in a part of the market that isn’t dominated by ultra-low-cost passive funds.
These new credit ETFs are gaining popularity with the adviser community and individual investors that have often been left out of some of the better performing areas of fixed income because the funds that invest in these assets have high minimums and limited liquidity. And notably, institutions are following too. According to an October report from Fitch Ratings, because ETFs are liquid and easy to get into and out of, many institutions are opting into credit ETFs rather than managing large bond portfolios themselves.
Some of the move into riskier fixed income via ETFs is not new. Fallen angel funds – those that invest in companies that have been recently downgraded from investment grade – have been around for several years. But asset flows into these funds are hitting new highs as investors rethink their credit exposure. The two largest funds iShares US Fallen Angels USD Bond ETF (FALN) and VanEck’s Fallen Angel High Yield Bond ETF (ANGL) are on pace for a record year. FALN has brought in USD4.3 billion year to date and ANGL has had asset flows of USD1 billion over the same period.
Both of these funds have been up throughout the pandemic as investors look for yield and new investment opportunities with companies that are likely to be only temporarily downgraded.
The interest in riskier corporate credit is also driving new players to enter the field. In October, BondBloxx, a company backed by several ETF industry veterans launched with the goal of providing even more granular exposure to corporate credit.
The firm plans to launch seven ETFs offering specialised exposure to the high yield market. Slicing up exposure into individual funds is common in equities but is still relatively new in fixed income.
“We think there is a significant unmet demand for more specialised exposure within fixed income,” explains BondBloxx co-founder Leland Clemons. The funds will provide sector exposure to industrials; telecom media and technology; healthcare; financial; energy; consumer cyclicals and consumer non-cyclicals. Clemons says that sector exposure funds can support investors if they want to take specific views on parts of the fixed income market – an option that was previously limited to equities funds.
The rapid growth of lending markets is also driving new ETF launches. Last year, California-based issuer Alternative Access launched the first CLO ETF – First Priority CLO Bond ETF (AAA) to provide access to the USD1 trillion CLO market. Janus Henderson followed shortly after with its Janus Henderson AAA CLO ETF (JAAA). Both funds invest in investment-grade CLOs.
Both funds caught the attention of ETF industry watchers when they launched in part because the CLO market is dominated by institutional investors and tends to be a little more volatile and harder to understand than vanilla bonds. But Alternative Access Managing Partner Peter Coppa argues that the funds fill a need. “From a market perspective, triple A CLOs are fairly liquid and they offer a hedge against interest rate risk and inflation. If you’re putting that in an ETF wrapper and making it available to institutions and advisers, you’re providing a solution that cuts out a lot of the overhead typically associated with this asset class.”
John Kerschner, Head of US Securitised Products at Janus Henderson Investors agrees. “We really see our fund as an option for advisers or small institutions that aren’t going to want to manage a CLO portfolio in-house. We could see some individual investors that understand the product buying it as well, but we’re still aiming at the professional community that wants lower cost exposure to this asset class.” Janus has filed for a second fund that will invest in BBB grade CLOs. Those CLOs are below investment grade.
A similar trend is underway in the floating rate note market. That market has also grown significantly in recent years and now stands at approximately USD1.2 trillion. At the end of October, Pennsylvania-based issuer Pacer ETFs, announced it had acquired Pacific Global ETFs’ fund, the Pacific Global Senior Loan ETF (FLRT). The fund will keep its ticker but operate under the name Pacer Pacific Asset Floating Rate High Income ETF going forward. Pacific Asset Management will actively sub-advise the fund.
FLRT provides current income to investors by investing predominantly in floating-rate loans of non-investment-grade companies. The ETF also invests in other adjustable-rate securities. Pacer ETFs Distributors President Sean O’Hara, tells ETF Express that funds like FLRT are gaining traction with advisers that want to expand the solutions they can offer in fixed income.
“There’s a lot of discussion right now about how portfolios are constructed – if you stay 60/40, the 40 is under pressure. If you go 70/30, that raises different issues in terms of equity risk. There is a lot of demand for products that can fit into the 40 or 30 and be a hedge while still generating income,” O’Hara says.
FLRT is part of a broader actively managed credit lineup at Pacer that provides a more opportunistic set of fixed income exposures. The family also includes the Pacer Trendpilot US Bond ETF (PTBD), a rules-based fund that offers exposure to both high yield and US treasuries. The fund’s exposure to high yield goes up or down dynamically based on a proprietary trading signal. When the fund pares back exposure to high yield it invests in treasuries to preserve capital.
Defined outcome ETFs – funds that are designed to limit performance, both gains and losses, to a specific range – are also becoming a bigger part of the portfolio construction discussion. Defined outcome ETFs offer a mix of equity and fixed income exposure with an options overlay. Investors participate in any upside in the market up to a certain threshold and then at a certain point in time the fund rebalances and resets, providing investors with a new upside cap dependent on market conditions at that time. If the market goes into corrections losses are also limited by the structure of the fund.
Allianz Investment Management recently launched two defined outcome ETFs that reset annually as well as the AllianzIM US Large Cap 6 Month Buffer10 Apr/Oct ETF (SIXO US) which resets every six months. The funds are based on work they already do in-house managing a significant derivatives investment business for the broader Allianz Group.
According to Johan Grahn, Vice President and Head of ETF Strategy at AllianzIM, defined outcome ETFs can also solve some of the concerns around low yields in fixed income especially for investors that are later in life and need income now. “There is a real issue for investors – especially if they are in retirement and want to be more conservative but the yields aren’t going to be there. With a defined outcome ETF you can lock in returns without significantly increasing the risk.”