Investors increased their bond risk appetite in June, chasing the prospect of higher yields, as Federal Reserve policy remains uncertain, according to data from State Street. Bond exchange-traded funds (ETFs) saw nearly $25 billion in inflows last month, with investors increasing their exposure to longer-term Treasuries by more than $6 billion, the asset manager said. But investors were also comfortable with the increased credit risk, funneling more than $1.6 billion into ETFs backed by bank loans and collateralized loan obligations (CLOs), State Street said. “These funds have seen inflows for 13 consecutive months, bringing in more than $18 billion during the period, as investors seek exposure with limited interest rate volatility amid rising interest rate risk from monetary policy changes,” Matthew Bartolini, head of research for SPDR Americas at State Street Global Advisors, wrote in a report last week. Chasing Yield Both bank loans and CLOs are good investments in today’s high-interest rate environment. Large institutional investors can buy bank loans that lending institutions offer to companies and benefit from the floating coupon rates on the loans. These coupons offer attractive yields as interest rates remain high. Bank loans are typically below investment grade, but because they are secured by the borrower’s assets, they are at the top of the list for lenders to get paid if the borrower goes bankrupt. CLOs are similar to bank loans. They are pools of floating rate loans offered to companies that may not be investment grade. CLOs themselves are made up of tranches, each with a corresponding risk profile. The top-ranked CLOs, or those deemed AAA by the rating agencies, are at the top of the list to get paid if the borrower goes bankrupt. The floating rate component of these assets allows them to perform well in a rising interest rate environment, but they may see a decline in investor income if the Fed begins to tapering policy. Buying actual bank loans or CLOs is out of reach for individual investors, but they can invest in the space through ETFs. These strategies should not make up the majority of an investor’s fixed income allocation, but 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 emerged as a popular choice with inflows of about $5.4 billion in 2024, according to FactSet. It has an expense ratio of 0.21% and a 30-day SEC yield of 6.6%. Know the risks Investors’ search for yield is happening at a time when the economy is doing well, earnings are growing and ratings momentum is improving, Bartolini said in an interview with CNBC. “We’re finally seeing more upgrades compared to downgrades in high-yield and investment-grade bonds.” He also noted that while investors may think bank loans and CLOs are inherently riskier because of their exposure to borrowers below investment grade, they should be mindful of interest rate risk in other parts of their portfolios during periods of Fed policy uncertainty. Bank loans and CLOs tend to have less price sensitivity to interest rate movements, namely short-term interest rates. Fixed income assets with longer maturities tend to be longer term and therefore more likely to be volatile when interest rates change. “Interest rate fluctuations are currently one of the big risks in fixed income portfolios,” Bartolini said. “Interest rate policy is shifting and uncertain, and the uncertainty is unlikely to ease as we move into the summer.”
Investors pumped $1.6 billion into bank loan, CLO ETFs in June: State Street
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