Summary
- JAAA is an AAA CLO ETF.
- Credit and interest rate risk are low. Dividends are good and growing. Strong risk-return profile.
- An overview of the fund follows.
Author's note: This article was released to CEF/ETF Income Laboratory members on February 15th.
The Janus Henderson AAA CLO ETF ( JAAA ) is an actively-managed ETF investing in AAA CLO tranches of senior secured loans. Simplifying things, JAAA invests in bundles of bank loans to smaller companies, and these investments are structured so as to minimize credit risk.
JAAA's low credit risk, low interest rate risk, and growing 5.3% forward yield make the fund a buy.
AAA CLOs - Overview
JAAA is an actively-managed ETF investing in AAA CLO tranches of senior secured loans. Let's have a closer look at what this entails.
Senior secured loans are variable rate loans from banks to smaller, riskier companies. These loans are senior to other debt, and secured by company assets.
Senior loans are sometimes bundled together in CLOs. Each CLO, or bundle of senior loans, is divided into tranches. Income from the senior loans is used to make payments to all tranches. Senior tranches get paid first, junior tranches get paid last. Investors, including JAAA, can buy into these tranches, and receive income from the bundle of senior loans.
In visual form.
Stanford Chemist SA Article
So, JAAA is investing in bundles of senior secured loans, receives income from doing so, and its income is senior to that of most other investors.
Let's go through some of the benefits of doing so.
JAAA - Benefits
Extremely Low Credit Risk
As mentioned previously, senior CLO tranches get paid first. AAA CLOs are the senior-most tranch, meaning it is the safest tranch, and an incredibly safe investments all around. The securities backing these CLOs effectively always generate sufficient income for the AAA tranch (not necessarily the case for lower tranhes), so investors effectively always get paid.
Securities backing these CLOs do sometimes default, but it is investors in the lower tranches who must bear any losses, initially at least. Small losses might wipeout BB investors, but AAA investors would remain unscathed. Moderate losses might wipeout BBB investors, but AAA investors would remain unscathed as well. Only catastrophic losses would be large enough to wipeout investors BB through AA, and these have never occurred in the past. As per Janus , not a single AAA CLO has ever defaulted, and the product has existed for several decades.
Due to the above, credit risk is extremely low. This is a significant benefit for the fund and its shareholders, and one which should lead to outperformance during recessions and periods of market stress.
JAAA is a relatively young fund, created in late 2020. As the fund is young and has not existed during a period of significant market stress, I can't really gauge its performance during such periods. I'm confident that the fund would perform quite well in a recession, even though I can't really point towards a prior one.
Low Interest Rate Risk
JAAA has low interest rate risk, for two key reasons.
First, is the fact that the fund sports a relatively low average maturity of 2.7 years. Senior loans tend to carry below-average maturities as, as these are relatively risky loans, and banks are loathe to make long-term loans to risky counterparties. Short-maturity securities have relatively low interest rate risk, as these securities are easily, quickly replaced in an investment portfolio. Investors will never be stuck with a low-yielding CLO, but they might be with a low-yielding 30Y treasury.
Second, is the fact that the fund (indirectly) invests in variable rate loans, which see higher interest rates when benchmark rates rise. Simplifying things a bit, if the Fed hikes rates, variable rate loans see higher rates too. Investor demand for these securities increases as their rates increase, which helps support their prices and returns. The extra income, from the higher rates, boosts returns further.
Due to the above, JAAA should outperform when interest rates increase, as was the case in 2022.
JAAA's low interest rate risk is a significant benefit for the fund and its shareholders, and particularly important during a period of heightened inflation and rising rates.
As JAAA has low credit and interest rate risk, overall risk and volatility is quite low. Expect relatively stable share prices, as has been the case since inception.
On a more negative note, JAAA's low interest rate risk does mean that the fund should underperform during a period of decreasing interest rates. Have been on a secular decline trend for decades, and could continue to decrease long-term. In my opinion, rates will likely remain elevated for at least one more year, as per Federal Reserve guidance and comments, and as per elevated, if declining, inflation. I simply see no short-term catalyst for lower rates, but conditions are obviously in flux, and rates could definitely decrease long-term.
Growing 5.3% Forward Yield
JAAA sports a TTM dividend yield of 3.1%, which is quite low. Although said yield is accurate, I don't believe it to be all that informative, as it includes payments from early 2022, during which interest rates and dividend payments were much lower. Annualizing the fund's latest dividend payment nets you a 5.3% yield, quite a bit higher. JAAA's SEC yield, which measures a fund's underlying generation of short-term income, stands at 5.5%, quite a bit higher too. In my opinion, these two figures are much more indicative of the dividends investors should expect moving forward. Chose to take the 5.3% figure as a forward yield. Said yield is quite a bit higher than 3.1%, and is reasonably good, if not outstanding, on an absolute basis.
JAAA's underlying holdings see higher income and interest rate payments as rates rise, which should ultimately result in higher fund dividends. Rates have risen since early 2022, so fund dividends should have seen very strong growth since, as did indeed occur.
JAAA's dividends should see more growth moving forward, due to the impact of recent rate hikes, and due to the possibility of even more hikes in the near future. Growth is obviously dependent on how interest rates evolve from here on out, and growth would almost certainly stall if the Fed is forced to pivot in the near future, but positive growth does seem very likely.
JAAA's growing 5.3% forward yield is a significant benefit for the fund and its shareholders, and particularly beneficial for income.
JAAA - Risk Analysis
JAAA is a safe fund with low risk and volatility, but these are not zero. The fund does sometimes see (small) losses, and its share price does fluctuate somewhat. JAAA is riskier, more volatile than the safest, least volatile assets in the market, including T-bills.
Although JAAA is incredibly safe, its volatility might be too much for the most risk-averse investors, or for those looking for a short-term, cash-replacement fund.
JAAA - Peer and Market Comparison
JAAA's risk-return profile seems to be quite strong, although the situation is somewhat complicated as CLOs are a somewhat niche asset class, with some differences relative to more common bonds and fixed-income securities.
JAAA's credit and interest rate risk are both incredibly low, roughly on-par with t-bills, which are probably the safest investments in the market. The fund's realized volatility, on the other hand, is quite a bit higher than that of t-bills and other short-term bonds, but much lower than average for a bond fund. Fundamentals say extremely low risk, the market says very low risk.
JAAA's 5.5% SEC yield, a standardized measure of short-term income, is comparatively quite good, higher than that of most short-term, high-quality bonds and bond funds. Same is true for JAAA's 6.4% yield to maturity, which measures a bond fund's expected returns at maturity, is also quite strong for a fund with its risk profile.
In general terms, it seems that JAAA is significantly less risky than average, with a slightly higher yield. The combination is quite strong, although obviously better suited towards more risk-averse investors.
A quick table with more detailed information of the above. I've selected comparison funds which are reasonably close to JAAA on characteristics and fundamentals. Credit risk is a qualitative assessment on my part, but based on the credit ratings on each fund's portfolio.
Conclusion
JAAA's low credit risk, low interest rate risk, and growing 5.3% forward yield make the fund a buy.
For further details see:
JAAA: AAA CLO ETF, Low Credit And Interest Rate Risk, Growing 5.3% Yield