Solve the Cash Conundrum With Highly Rated CLO ETFs

As of the end of the first quarter, there was approximately $8 trillion in money market funds — a staggering sum, considering the recent performance of equities. Yes, some of that capital is “dry powder” for institutional investors or required cash reserves for fund managers, but $8 trillion is still a jaw-dropping amount.

It implies that some advisors and retail investors want to generate more income without equity market risk, but don’t know where to turn. The confusion is amplified at a time when cash yields are declining and, as it appears unlikely that the Federal Reserve will cut interest rates this year, potentially making some individual bonds and select fixed income ETFs unappealing.

Fortunately, that’s not universal across the bond ETF landscape. Advisors and investors pondering money market alternatives may want to consider the expanding landscape of AAA CLO ETFs.

“[Bonds]—particularly core and limited-term strategies—offer an alternative that can balance income potential, risk management, and portfolio resilience. And there’s an even more conservative option, AAA CLOs, which have meaningfully topped the performance of money markets, on average, since late 2011,” noted Fidelity.

CLO ETFs Catching On

CLO ETFs, including the Fidelity AAA CLO ETF (FAAA), focus on collateralized loan obligations. Even the highest rated CLOs offer more compelling yields than many U.S. government and municipal bonds, making ETFs such as FAAA valid alternatives to money markets.

The high credit quality advertised in AAA CLO ETFs is alluring for risk-averse fixed income investors, but funds such as FAAA offer other perks.

“One of the highest-yielding in recent years has been AAA-rated collateralized loan obligations (CLOs), which carry low interest rate and default risks compared with other fixed income option,” added Fidelity.

AAA-rated CLOs and the corresponding ETFs can be viewed as defensive assets, but that doesn’t mean there’s no upside to be had. As Fidelity noted, AAA-rated CLOs generated positive returns in 88% of months since 2011.

“Since inception in late 2011, the benchmark JP Morgan US CLOIE AAA Index has returned about 3.4% a year, on average. AAA-rated CLO ETFs also have an attractive yield per unit of duration vs. other fixed income asset classes and a strong track record of positive monthly returns,” according to the asset manager.

The actively managed FAAA debuted in February alongside the Fidelity CLO ETF (FCLO). Both ETFs have fee waivers in place for their first 12 months on the market.

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