US CLO ETFs, for instance, have grown into a multi-billion dollar market and sources say that four managers are at various stages of bringing CLO ETFs to Europe.

Meanwhile, the US CLO listed-fund market is growing fast with two fund managers, Sound Point Capital Management and Pearl Diver Capital, recently launching public funds.

Bill Bielefeld, US-based partner at law firm Dechert, says the firm is engaging in discussions with various managers on setting up listed funds. CLO performance — as public as it now is — has drawn more investors into the space. Demonstrating resilience in the face of volatility such as in recent days is a good way of getting investors on side.

"Those funds have tended to trade quite well and are able to raise capital on a continuous basis, given they are trading at a premium to NAV,” Washington-based Bielefeld says.

“That's certainly not always the case for listed closed-ended funds in other asset classes and it’s what’s given people confidence to get out there and get listed, even if it’s a smaller initial fundraise.”

Listed closed-ended funds represent permanent capital for managers compared to open-ended funds, or an ETF or private fund, where investor redemptions necessitate the liquidation of assets.

“With a listed closed-ended fund, investors have liquidity through exchange trading, but the capital remains in the fund, which is obviously very attractive from a managers’ perspective,” added Bielefeld.

The emergence of more listed CLO vehicles, alongside the rise of CLO ETFs, has opened the doors for retail capital, family offices, and high-net worth investors. It has also given institutional investors an alternative way to allocate to CLOs.

ETFs set to make their way to Europe

In the US, sources tell 9fin that around 85% of total ETF holdings are in US CLO triple-As.

This makes CLO ETFs, as a group, among the top 10 holders of CLO triple-As and should the pace of growth continue this year, they could easily be in the top five. In the short term, the incremental ETF buyer base is positive from a spread compression perspective.

With all the success of ETFs in the US, it wasn’t exactly a surprise when CLO fund managers looked to tap investors across the continent.

Josy Mazzucchiello, portfolio manager at Partners Group, tells 9fin there are some firms planning to set up ETFs that would invest in European CLOs.

Retail investors are attracted by the low fees associated with ETFs structure, and if associated with senior CLO tranches, it could replicate the success that some of the funds had in the US.

But Mazzucchiello cautions that managing liquidity may become more difficult for ETF managers in this asset class as they scale and become very large.

“We have seen the market for CLO ETFs grow rapidly in the US and at $10bn it should be straightforward enough to manage liquidity for a book of triple-A rated CLOs,” he said.

“But taking a longer-term view, issues could arise if, say, this becomes a $100bn+ market and there are a flurry of redemption requests. CLO triple-As are generally stable, but the CLO market is always prone to headline risk.”

“When rates go lower, the velocity of retail money could go out of these funds quicker,” said another CLO investor. “Take a look back at historical outflows in the loan market. Although that space represented quite a small portion of the market, outflows can cause meaningful volatility in prices in a compressed period of time.”

One fund manager says that the upcoming European CLO ETFs will be UCITS-compliant. This banner imposes restrictions on managers (such as ensuring portfolios are diversified), but the UCITS label is crucial for attracting European and Asian investors.

Choosing a wrapper that works

Closed-ended funds such as those by Pearl Diver and Sound Point can more easily hold illiquid assets, allowing managers to invest in junior CLO debt tranches, or CLO equity tranches even if the share price takes a hit.

Sound Point Meridian Capital closed at $19.02 yesterday (5 August), down from $19.95 on 31 July. Pearl Diver Credit Company closed at $19.71 yesterday versus $20.55 on 31 July.

This is, of course, the opposite of an ETF which needs to meet liquidity requirements on a daily basis, and is therefore more likely to invest in senior tranches or higher-rated debt tranches. Most CLO ETFs are focused on triple-A rated CLO tranches (that being said, Janus Henderson’s B-BBB CLO ETF topped $1bn assets under management earlier this month).

The volatility that swept over liquid markets late last week gave a glimpse into how well-positioned ETFs are to withstand short, sharp shocks. So far, so good — Janus Henderson AAA CLO ETF registered $81m of inflows on Friday (2 August), according to ETF.com, and followed that up with a further $5.1m yesterday (5 August), although CLO mezzanine ETFs did experience outflows. Loan funds were hit harder.

CLO ETFs, which have flourished in the past couple of years, have a create and redeem process. But using a closed-ended fund can also allow for more leverage to be used versus an ETF.

Interval funds meanwhile, from a manager's perspective, are somewhat similar to a listed closed-end fund in that the money is near-permanent.

9fin reported in November Octagon Credit Investors and XA Investments teamed up as they sought to launch a CLO-focused interval fund named Octagon XAI CLO Income Fund.

These funds tend to raise capital a little more slowly, but they can do it on a daily basis.

As part of an interval fund, managers are required to offer to repurchase at least 5% of shares on a quarterly basis.

“The challenge is CLO equity is not the most liquid asset class,” says one investor. “An interval fund requires 5% redemption offers quarterly, so 20% a year, which is not great.”

“CLOs are not real estate but if a lot of people get out it, it’s hard for managers to provide redemptions.”

An interval fund’s fee structure is lower than listed funds, sources say, with fees generally around 1.25-1.5% versus around 1.5%-1.75%.

“Interval funds require distributors and a large portion of the CLO management fees go to them, which is not as attractive for managers,” says one investor.

In addition, the trade-off between interval funds and an ETF, or listed closed-ended funds, is that you transact at NAV and you are getting quarterly liquidity at NAV. Listed closed-ended funds however can trade at a discount.

One fund manager says: “I can go to my Schwab account right now and buy one of these closed-ended CLO listed funds, but if I want to sell it in the month, it may be trading at a discount. If I want to buy into a CLO interval fund, however, investors know they are going to go in at NAV and get out at NAV.”

Watch out for those activists

Regulators impose stringent requirements for funds that are geared towards retail investors.

These regulations mandate high levels of transparency regarding the underlying assets and their risk profiles, making the approval process for CLO funds both lengthy and intricate.

“The listed closed-end fund market in general can prove more challenging to get a product done versus an interval fund or an ETF,” said Bielefeld.

“It’s not the most accessible market out there. You need to get underwriters on board, managers need to create the interest for the products and they're expensive for the managers on the front end — managers are often paying some, if not all, the sales load and the organization and offering costs. There's really got to be a strong commitment from the manager to get one of these done,” he said.

With public funds comes public scrutiny and one thing managers need to be mindful of is activist investors.

Listed closed-end funds can trade at a discount, so there are arbitrage opportunities. Activist investors will buy the stock at a discount and then seek to get the manager to take actions to narrow the discount so people can transact at NAV.

“The good news is that CLO funds have tended to trade well, so there has not been that arbitrage opportunity,” said Bielefeld. “To date, we haven’t seen activist investors take big positions or cause big headaches in any of the CLO-focused funds.”

One investor says while this is a slight risk, there are ways a manager can turn things around if a fund is underperforming. They can, for example, sell some of the assets and repay investors, which will bring the stock back closer to net asset value.

Still, it’s a tough market given the importance of balancing investments (NAV) and investor engagement (share price).

It’s not all unchecked growth though as some managers have decided to throw in the towel.

On 25 July, communications from the board of directors of Marble Point Loan Financing suggested it could wind down.

“Given the material reduction in its ordinary share capital following the conversion on 4 August 2024, the board is actively considering options for the future of the Company, which may include withdrawing the Company's admission to trading on the London Stock Exchange (subject to complying with the applicable legal and regulatory requirements)”

It follows after Blackstone opted to wind down Blackstone Loan Financing in June 2023.

The board took into consideration the “prevailing discount to net asset value at which the shares have been trading, the market capitalisation and liquidity of the shares, and the company’s structure.”

In addition, the board also added the fund was “limited in its reinvestment opportunities and ability to grow through further share issuance.”

Both these funds are captive CLO equity strategies.

Follow the leaders

Pearl Diver Capital listed its fund, Pearl Diver Credit Company, on the New York Stock Exchange on 18 July. Click here to watch the firm ringing the opening bell.

The IPO aimed to raise $44m through the issuance of 2.2m shares at $20 per share. Underwriters had a “45-day option to purchase up to an additional 330,000 shares of common stock to cover over-allotments, if any.”

On Friday 19 July, Pearl Diver Credit Company announced the closing of the IPO with total net proceeds of $50.6m. Kingswood Capital Partners acted as the sole bookrunner for the offering.

“We believe that this is an ideal time for a broader universe of investors to devote capital to the alternative credit market, which for decades has provided a string of attractive benefits to large institutional players,” said Indranil (Neil) Basu, Pearl Diver’s chief executive officer in the announcement.

9fin first reported Pearl Diver was looking to launch a listed CLO equity fund in October last year and in June, highlighted the firm would be looking to launch the IPO in Q3 with details of the fund’s initial portfolio.

Likewise, in November, 9fin first reported Sound Point was preparing to launch its fund and in June, sources indicated the firm was getting closer to the IPO, looking to offer 3.75m shares of common stock at $20 per share.

Later that month, Sound Point Meridian Capital underwent its IPO of $80m in shares of its common stock.

Oppenheimer & Co, B. Riley Securities, Janney Montgomery Scott, Piper Sandler & Co, Clear Street and Wedbush Securities acted as underwriters for the offering.

In conjunction, Sound Point Meridian Capital bought a $320m portfolio of CLO tranches from an affiliated private fund in exchange for shares of its common stock.

Pearl Diver and Sound Point join the plethora of CLO listed vehicles already in the market.

Eagle Point Capital, for example, launched one of its public funds Eagle Point Credit Company in 2014. According to its June 2024 factsheet, that fund invested 69.3% in CLO equity, 15.1% in CLO debt, 4.8% in regulatory capital relief, 6.1% cash, 1.3% in warehouses and 3.4% in other assets, as of 30 June. It has $855.4 million total net asset value.

Oxford Lane and OFS Management have similar CLO funds with Oxford Lane Capital Corporation and OFS Credit Company, respectively. In 2014, Fair Oaks launched the UK’s first CLO-focused listed fund in Europe since the 2008 financial crisis with Fair Oaks Income Fund. Axa Investment Managers runs Volta Finance while Chenavari manages Toro Income Fund.

Last year, Carlyle Group took over management of Vertical Capital Income Fund, renaming it Carlyle Credit Income Fund, which invests in equity and junior debt CLO tranches.

Explore our news and analysis for our latest scoops and in-depth analysis.