CLOs Have Become the Third Most Liquid Fixed Income Market in the U.S., Behind Only Treasuries and Agency MBS. This was stated by John Kerschner, Global Head of Securitized Products and Portfolio Manager at Janus Henderson, during the Madrid Investment Summit held by the firm in September.
However, Kerschner acknowledged that this asset still offers a certain complexity premium, as not all investors are equally informed about how it works. The firm has been making ongoing efforts to educate its clients—even if that means this premium disappears—because they believe the investment opportunity in CLOs is more alive than ever. Thus, Kerschner—who manages the world’s largest actively managed CLO ETF (JAAA)—used his appearance at the event to give a class on the structuring, functioning, and characteristics of these investment instruments.
Demystifying Asset Securitization
His presentation began by addressing the very concept of securitization, with the manager noting that “it’s a big word that for some is complicated and, for others, even scary—but it doesn’t have to be.”
“Securitization is, and always has been, about gathering a pool of loans, bundling them, establishing a framework for them, and then taking the cash flow from those loans and splitting it into different levels of risk and return. That’s it. Nothing more, nothing less,” he explained simply. This applies to an auto loan, a mortgage, real estate credit, or a corporate loan—though the process has evolved over time.
Kerschner recalled that the loan market was born in the 1980s as a solution for companies that were too small or illiquid to access financing through high-yield debt. Initially, these companies turned to banks for loans, although under very strict conditions. Later, Wall Street saw an opportunity in this market, and several players started what we now know as the leveraged loan market. “The problem is that leveraged loans are fairly risky, even today, with an average rating of B,” the manager pointed out.
Continuing his explanation, Kerschner noted that “even with all the institutional investors available, the leveraged loan market began to run out of investors.” At that point, the idea emerged to use securitization technology—already present in ABS, mortgages, or real estate markets—and apply it to corporate loans. “That’s the magic of CLOs: you take something that’s relatively risky, somewhat liquid and volatile, and create other assets that are much safer, more liquid, less volatile, and with better ratings,” he summarized.
Key Facts About CLOs
The expert shared several important data points to better understand the size and behavior of this asset class. For starters, he estimates that auto ABS represent a $200 billion market and have not experienced any defaults since the late 1980s—“not even in the AAA segment.” He clarified that while some loans did default, “the securitization was structured to handle it,” which is why CLOs have not seen a single default in 40 years. Furthermore, Kerschner added, “since the Global Financial Crisis (GFC), no investment-grade CLO has ever defaulted.” “The safety works, and securitization works most of the time—especially in CLOs,” he concluded.
He pointed out that U.S. GDP amounts to $30 trillion and the EU’s to $20 trillion, while the U.S. securitization market is valued at $5 trillion—that is, about 17% of GDP “excluding agency mortgages.” In Europe, securitizations amount to just $660 billion. In short, the U.S. market is five times larger than the European one, and according to Kerschner, this distinction matters because “loans that are not securitized sit on the balance sheets of European banks; that’s why European banks are not as dynamic as U.S. banks.”
Overall, based on the expert’s data, the global CLO market is valued at $1.7 trillion, while the European market stands at about $400 billion. “Obviously, it’s not as large as the U.S. market, but proportionally it’s fairly close,” he concluded.
What Makes CLOs Special?
The remainder of Kerschner’s masterclass focused on the four main characteristics attributed to CLOs: return, safety, liquidity, and diversification.
On the first point, the expert noted that an asset combining higher yield with lower volatility clearly points to a better Sharpe ratio; CLO returns exceed those of corporate credit, with lower volatility. While acknowledging that CLO yields are floating, “even if you hedged that component, they would still show lower volatility,” he explained.
Regarding safety, Kerschner stressed that no AAA CLO has defaulted since the GFC, thanks to tightened rating agency criteria.
On liquidity, the portfolio manager highlighted the firm’s experience trading CLOs during the extreme market conditions of March 2020 at the onset of the pandemic. “This experience—especially with AAA CLOs—gave us the confidence to launch JAAA in October 2020.” Today, this ETF can trade “hundreds of millions in market value in a single day, with a one-cent bid-ask spread,” and has reached a record volume of $1.2 billion in a single session. During the significant volatility seen on April’s Liberation Day, the ETF dropped between 1% and 2%, leading the manager to note that this vehicle “has more volatility than cash, but only during dislocations.” “CLOs are much more liquid than people think,” the expert concluded.
Finally, on diversification, Kerschner stated that “CLOs are quite similar to corporate credit but offer much better diversification than leveraged loans and high yield.” He believes this is especially relevant for investors in fixed income products based on Aggregate-type indexes, where CLOs are not represented due to their floating-rate nature. “Many people are underexposed to this asset class simply because it’s not in the indexes,” the manager concluded.
