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The Panagram BBB-B CLO ETF (NYSEARCA:CLOZ) is an ETF which invests in CLOs with ratings BBB-B. The fund seeks to provide high levels of current income along with capital preservation.
CLOZ is a fairly innovative product as it allows investors to access the below investment grade CLO market at a reasonable cost. The fund has net assets of $405 million and charges a net expense ratio of 0.50% (which is inline with its closest peer the Janus Henderson B-BBB ETF).
Currently, CLOZ is not rated by Seeking Alpha analysts as the fund does not receive a lot of coverage. There are four reasons why I am bullish on CLOZ and initiating coverage with a Strong Buy:
1. Strong Historical Performance
2. Strong portfolio management team
3. BBB and BB CLOs are highly attractive vs similarly rated corporate securities
4. Highly diversified portfolio
Unique Product
CLOZ launched in January 2023 and was one of the first ETFs to offer investors exposure to below investment grade CLOs. While peers such as the VanEck CLO ETF (CLOI) and the Janus Henderson B-BBB ETF (JBBB) had launched prior to CLOZ, these funds tend to focus more on higher quality CLOs and do not have significant exposure to BB rated CLOs. For context, JBBB currently has 3.9% exposure to BB rated CLOs while CLOI has no exposure to BB rated CLOs. Currently, CLOZ has close to 44% exposure to BB rated CLOs and thus continues to represent a fairly unique product.
Historically, the CLO market was dominated by institutional investors such as asset management companies and insurance companies. However, this is starting to change as a series of ETFs have launched which allow individual investors to access the CLO market. CLOZ stands out due to its emphasis on BB CLOs while other products have focused more on higher rated securities.
While CLOZ was slow to gather assets initially, that has changed and assets of the fund have risen rapidly over the past year.
1. Strong Historical Performance
As shown by the chart below, since inception, CLOZ has delivered strong performance on both an absolute and relative basis. Since inception, CLOZ has delivered a total return of 21.94%. Comparably, CLOZ’s closest peer, the Janus Henderson B-BBB CLO ETF has delivered a total return of 19.73%. I also view bank loans as a reasonable comparison given the fact they are also floating rate instruments and tend to carry significant credit risk. The Invesco Senior Loan ETF (BKLN), an instrument which carries arguably more credit risk than CLOZ given its significant exposure to B rated securities, has delivered a total return of 12.9% during the period since CLOZ’s inception.
In addition to delivering strong performance, CLOZ has also delivered low volatility. As shown by the chart below, CLOZ has delivered an average 30 day trailing volatility of 2.64% since inception. This compares favorably, to JBBB and BKLN which have experienced average 30 day trailing volatilities of 3.47% and 3.22% respectively. CLOZ’s realized historical volatility also compares quite favorably to the broader fixed income market as the iShares Core US Aggregate Bond ETF has experienced significantly higher average volatility of 5.67%.
2. Strong Portfolio Management Team
Given the highly illiquid and complex nature of the BBB and BB CLO markets, I believe having high quality portfolio management is essential for any CLO ETF focused on this market.
CLOZ has two portfolio managers: John E. Kim and Tim Wickstrom. Both Kim and Wickstrom are co-founders of Panagram and have significant experience in the structured products business. Kim was previously Head of Structured Products at Eldrige and before that was a Managing Director at Natixis and head of CLO structuring at Deutsche Bank. Wickstrom was previously a director at Eldrige.
More broadly, Panagram is a structured credit specialist firm and has total assets under management of $16.8 billion in CLO Debt, CLO Equity, ABS, and Private Solutions.
As a specialist investment management firm, I believe Panagram is well positioned to select attractive securities for CLOZ. Moreover, as a smaller firm the portfolio managers are better able to scale their best ideas in a product such as CLOZ. Comparatively, a larger asset management firm may have a more difficult time scaling up best ideas as there is likely to be a large base of separately managed accounts competing for the same allocation of securities.
3. BBB and BB CLOs Are Attractive Vs Similarly Rated Corporate Securities
Currently, CLOZ offers a SEC yield of 9.17%. I believe the most reasonable comparison in terms of corporate securities is BKLN as the fund hold floating rate loans which are below investment grade. Currently, BKLN has an SEC yield of 7.99%. Moreover, BKLN is also significantly more risky in terms of credit quality as the fund hold 48% exposure to securities rated B and CCC while holding just 3% exposure to securities rated BBB.
Comparably, as shown by the chart below, CLOZ holds 43.8% in BB rated securities, 50.7% in BB rated securities, and 5.5% in cash. Thus, on a relative basis CLOZ offers a significant yield pickup and improvement in credit quality compared to BKLN.
In addition to offering more yield vs traditional corporate debt, CLOs also have historically experienced lower default risk. Historically, BBB CLOs have experienced a default rate of roughly 0.30% while BB CLOs have experienced a default rate of 1.26%. Comparably, over a 5 year period BBB and BB corporate securities have experienced default rates of 1.79% and 7.26% respectively.
4. Highly Diversified Portfolio
Given the relatively risk nature of any single CLO, I view diversification as a key consideration. An overly concentrated portfolio can result in significant risk to one underlying company which can prove problematic in the event something goes wrong for the company.
Currently, CLOZ holds 148 different securities and the largest single holding accounts for just 2.01% of the fund’s total portfolio. The fund’s top 10 holdings, excluding cash, account for just 15.1% of the total portfolio. Additionally, the fund is well diversified in terms underlying industry exposure. I view this as a key positive as risks tend to be different for different industries. For example, financial services credits tend to be driven more by macro risk factors while technology and healthcare company credit risk tends to be driven more by individual company circumstances. That said, all companies have some degree of exposure to macro economic conditions.
Illiquidity Is A Key Risk
One risk that investors should be aware of is that BBB and BB rated CLOs tend to be highly illiquid. This means that buyers and sellers tend to pull back from the market during times of market stress. As a result, BBB and BB CLO prices can experience significant volatility in the event of a significant market stress event.
CLOZ was launched in January 2023 and thus the product has not traded through a stressed market environment. However, investors can look to JBBB in order to get a sense of how CLOZ might trade during a market stress event. As shown by the chart below, JBBB experienced a roughly 10% drawdown in 2022 as credit and equity markets sold off aggressively. Given that CLOZ has significantly more exposure to BB rated securities, I would expect CLOZ might experience a more significant decline than JBBB in the event of a market stress event. That said, investors who are able to hold their position through such periods of volatility are typically rewarded as CLOs tend to bounce back fairly quickly once market conditions normalize. This was the case during the 2022 market stress event. As shown by the chart below, JBBB had recovered most of its initial losses before equity markets fully recovered.
Conclusion
CLOZ is a fairly new product and stands out due to its significant holding of BB rated CLOs. Comparably, most other CLO ETFs are focused on higher rated parts of the CLO market.
CLOZ has delivered strong historical performance with low levels of volatility. The fund also benefits from a high quality portfolio management team at a firm which is focused on structured credit. The fund is also highly diversified which limits exposure to any one issuer.
I view BB and BBB rated CLOs as highly attractive vs comparable corporate securities as CLOs currently offer more yield with less credit risk.
For these reasons, I view CLOZ as a highly attractive investment opportunity and am initiating coverage with a Strong Buy rating. I would consider downgrading the fund if credit spreads tighten significantly such that the yield premium vs comparable rated corporate securities is lower.