2023-12-19 07:08:51 ET
Summary
- JAAA is one of my top-income ETFs for more conservative, short-term investors.
- The fund is broadly similar to t-bills and BIL, with a higher yield, but a bit more volatility.
- A comparison of these two funds follows.
I've covered the Janus Henderson AAA CLO ETF (JAAA) several times in the past . I've been bullish, due to JAAA's good, growing 6.0% dividend yield, stable share price, and very low credit and interest rate risk. JAAAs value proposition is quite similar to that of t-bills, so thought to compare the fund with the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL), the largest t-bill ETF in the market.
JAAA focuses on AAA-rated CLO tranches, somewhat complicated securities, sometimes illiquid. BIL focuses on t-bills, much more simple, liquid investments.
Both funds have above-average yields and dividend growth track-record. JAAA yields a bit more, with a 6.0% yield versus 4.8% for BIL.
Both funds have negligible interest rate risk, an advantage when rates rise, disadvantage when these decrease.
Both funds have extremely low credit risk. BIL is arguably a bit safer, as nothing beats t-bills in this regard.
Both funds have relatively stable share prices. BIL is much more stable, with a 0.2% max drawdown, compared to 2.6% for JAAA.
Considering the above, JAAA is definitely the higher-risk, higher-yield choice out of the two. As such, more conservative, short-term investors might prefer BIL, those looking for a bit more in yield might prefer JAAA.
On net, I believe JAAA to materially superior to BIL, as the former provides investors with materially higher dividends with only a bit more risk.
Strategy and Holdings Comparison
JAAA - AAA-rated CLO Tranche ETF
JAAA is an actively-managed ETF investing in senior secured CLO tranches. Let's have a closer look at what this entails.
Senior secured loans are variable rate loans from banks to medium-sized, riskier companies. There are exceptions, but not too many. 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 can buy into these tranches, and receive income from the bundle of senior loans. Quick graph of how these are structured. I've bolded JAAA's main tranche below.
JAAA invests in senior secured CLO tranches, meaning it invests in bundles of senior loans, and receives income for doing so. JAAA focuses on AAA-rated tranches, the most senior tranche of them all, with smaller investments in AA and A-rated tranches.
BIL - Simple T-bills Index ETF
BIL is a simple t-bills index ETF. These are much simpler securities, and don't require lengthy explanations, unlike CLOs.
In my opinion, BIL's simplicity is an important positive for investors. Investors know what to expect from the fund, and their investment can't really go wrong or behave in unexpected ways.
Credit Risk Comparison - BIL Technical Winner
JAAA focuses on AAA-rated CLO tranches, which means the fund and its investors get paid first, before all other tranches, and before almost all investors in these tranches (they get paid at the same time as other AAA investors).
Getting paid first means credit risk is low, for obvious reasons. In practice, credit risk is extremely low, as the securities backing these CLOs almost always generate sufficient income to pay the AAA-rated tranches. As per S&P , not a single AAA CLO has ever defaulted, and the product has existed for several decades.
JAAA has small, single-digit investments in AA and A-rated CLO tranches too. These are sufficiently senior as to have very low credit risk as well. AA-rated CLOs have 10Y cumulative default rates of 0.06%, A-rated a bit higher at 0.04%. Both figures are extremely low, and average out to 0.0% in annual default rates.
As should be clear from the above, JAAA's underlying holdings have negligible credit risk and default rates. For default rates to meaningfully increase, corporate default rates would have to spike, quickly and sharply. How much is unclear, but based on the above, defaults would have to be materially higher than during the dot-com bubble, financial crisis, and coronavirus pandemic.
Based on data from Steven Bavaria , one of the foremost experts on SA on these issues, corporate default rates for riskier issuers would have to reach +30% for significant defaults on high-quality CLO tranches. Default rates on high yield bonds, similar securities, have averaged 3.6% for the past 30 years or so, peaked at 16% during the 90s.
BIL exclusively invests in t-bills. Said securities are issued by the U.S. Treasury, and backed by the full faith and credit of the U.S. government. Credit risk is effectively nil, barring an unprecedented U.S. government default.
Considering the above, it seems quite clear that both JAAA and BIL have extremely low credit risk. JAAA arguably has a bit more, due to its investments in AA and A-rated tranches with higher-than-zero default rates. As such, more conservative, risk-averse investors might prefer BIL over JAAA. Still, both funds are quite safe, and the differences here are marginal.
Interest Rate Risk Comparison - Tie
JAAA indirectly invests in senior loans, securities with variable rates and negligible interest rate risk. The CLO debt tranches themselves also have these characteristics. Duration stands at 0.05 years.
BIL invests in t-bills, securities with very short maturities, and negligible interest rate risk. Duration stands at 0.12 years.
As should be clear from the above, both funds have extremely low duration and negligible interest rate risk. Although JAAA's duration is technically a bit lower than that of BIL, I don't that the tiny difference will meaningfully impact performance.
Considering the above, both funds should outperform most bonds and bond sub-asset classes when interest rates rise, as has been the case since early 2022.
On the flipside, both funds should underperform if rates decrease. Specifics and investor expectations matter. Right now, investors are expecting quite a few rate cuts next year , and are pricing bonds accordingly. As such, smaller, more moderate rate cuts might not necessarily lead to underperformance for either fund. Significant, swift cuts would almost certainly lead to underperformance, however.
In any case, both JAAA and BIL have negligible interest rate risk or exposure, with all the benefits and downsides that entails.
Volatility Comparison - BIL Clear Winner
BIL's t-bills have almost no credit or interest rate risk, and so their prices tend to be incredibly stable. BIL's shares generally trade between $91.4 - $91.7, a very tight range. Almost all of the volatility here is due to (temporarily) retaining income received within the fund before distributing it to shareholders, and not reflective of any real risk or asset price volatility.
JAAA's AAA-rated CLO tranches are also incredibly safe securities, but their volatility is a bit higher. The fund tends to trade within a range of $49.6 - $50.4, but there have been exceptions, with share prices reaching $48.8 during late 2022.
Comparing drawdowns shows the same. JAAA has experienced a drawdown of 2.6% since inception, much higher than BIL at 0.2%. At the same time, drawdowns for both funds are much lower than average. JAAA is riskier than BIL, but quite safe relative to the broader market.
CLOs tend to trade with greater volatility than expected, accounting for their credit and rate risk. Although I am not completely sure why this is the case, I have two hypotheses.
The first is the fact that CLO tranches are somewhat illiquid, complicated, volatile, and less well-known investments, and so must carry higher yields to attract investors. I wouldn't invest in JAAA if it didn't yield materially more than t-bills, and I think the same is true of many investors.
The second is perceptions of risk. CLOs are complicated securitized products, and reminiscent of CDOs, which imploded during the past financial crisis. CLOs are different and safer, but the perception remains.
Importantly, the reasons above imply that investors can receive excess dividends and returns from investing in CLOs without undue risk.
In any case, JAAA is much more volatile than BIL, an important negative and disadvantage. At the same time, JAAA might be too volatile for the most risk-averse investors looking for a cash-replacement fund. It does remain a broadly safe, stable, short-term investment, however.
Dividends Comparison - JAAA Clear Winner
Both funds currently sport good, above-average dividends, across most relevant dividend yield metrics. Of the major bond sub-asset classes only high-yield bonds have higher yields, and that is with much greater credit risk. JAAA does yield around 1.0% - 1.5% more than BIL, a meaningful amount, and an important benefit and advantage for the fund.
Both funds should see swift dividend cuts if the Fed were to cut rates, however. Nevertheless, I believe that both funds will likely retain strong dividend yields even after the Fed cuts rates , considering their starting yields and spreads to peers.
As an example, the Fed would have to cut rates by more than 2.5% for medium-term treasuries to have higher (SEC) yields than JAAA, 1.0% for BIL. Similar figure relative to bonds in general.
Latest Fed outlook is for 0.75% in cuts next year, another 1.0% in 2025. JAAA would still yield more than treasuries next two years under current Fed trajectory. BIL would yield a bit less, but that is almost always the case for t-bills.
Under these conditions, I believe that both funds offer investors strong dividend yields, potential Fed rate cuts notwithstanding.
Performance Comparison - JAAA Clear Winner
Returns for both funds and some of the more relevant bond sub-asset classes.
BIL's performance is almost entirely dependent on Fed rates: higher rates means higher returns, and vice versa. Rates have been high these past twelve months, as have BIL returns. Rates were much lower in the past, as were BIL returns. Due to the fund's low interest rate risk, it has outperformed most bonds and bond sub-asset classes these past three years. It has underperformed these past ten years, and will likely underperform the next ten years as well (t-bills generally yield less than other bonds).
JAAA's performance is strongly dependent on Fed rates too, but spreads and volatility matter too. JAAA has significantly outperformed most bonds and bond sub-asset classes since inception, more than three years ago. The fund's track-record is outstanding, in part due to timing: the fund was created one year before an unprecedented hiking cycle. Future returns are dependent on future Fed policy, amongst other variable. I'm expecting good, above-average returns, considering current yields and spreads.
Comparing JAAA to BIL, it seems quite clear that JAAA tends to outperform, due to its higher yield. JAAA's stronger performance is a significant benefit for investors, and advantage relative to BIL.
JAAA versus BIL - Key Comparison
In my opinion, choosing between JAAA and BIL is simple.
Do investors prefer JAAA's stronger expected and historical returns:
Or BIL's lower risk, volatility, and outperformance during periods of market stress:
Seems clear that the above choice is ultimately dependent on the specific needs or risk-return profile of each investors. Those looking for the most safety and stability might prefer BIL, others JAAA.
As for myself, I think JAAA is quite clearly the stronger choice. I would gladly take a 2.5% higher drawdown for a 1.5% higher dividend yield, as that is a marginal increase in risk for a respectable increase in income. For what it's worth, JAAA has higher risk-adjusted returns than BIL, although as recent market conditions have been unusual, take these figures with a grain of salt.
Conclusion
JAAA and BIL both sport above-average yields, and have very low credit and interest rate risk.
JAAA yields a bit more, with a 6.0% yield versus 4.8% for BIL.
BIL is a bit less volatile, with a 0.2% max drawdown versus 2.6% for JAAA.
Both are good investment opportunities, and buys. JAAA seems on net stronger, in my opinion at least.
For further details see:
JAAA Vs. BIL: Which Is Best For Income Investors And Retirees?