CJ Doherty: Welcome to the Lending Lowdown. I'm CJ Doherty, director of analysis at LSEG LPC. And today's episode is a notable one for us, as I'm delighted to say it's our 25th podcast in the series. And in this episode, we're going to cast a spotlight on CLO ETS as there are very topical in the CLO and loan market these days given their expanding the investor base for the CLO asset class and we will also touch on the broader securitized market too. So to shed some light on these growing market segments, it's great to be joined by John Kerschner, head of US securitized products and portfolio manager at Janus Henderson Investors. Thanks for joining me, John.
John Kerschner: Thanks CJ. Pleasure to be here.
CJ Doherty: So John, it's it's all good to start with a little bit of background information first. So before we dive into questions on the market, can you tell our listeners a bit about yourself and Janus Henderson?
John Kerschner: Yeah, sure. So I graduated Business School from Duke University back in the mid 90s and I joined a small money manager. That was started by a professor at Duke by the name of Smith Breed and Associates. So start my investment management career then was doing agency mortgages for a couple of years and then was given the ABS slash non agency mortgage sector kind of cut my teeth on and and did that for several years. i was right in the midst of it pre GFC or global financial crisis with the huge increase in the subprime mortgage market and and we know how that kind of turned out. I actually left that firm in late 2006 and joined a hedge fund that focused on commercial real estate globally through the GFC. That platform basically ended up not growing as much as I liked during the GFC. We did some distress debt investing, so it worked out OK, but I wanted to really join a firm where I could build a team, build a platform, build a world-class securitized team and and that so happened to be Janus at the time. Now, Janus Henderson and I joined them in 2010 to build out the team and now we're a team of nine, soon to be 12 here in Denver, another six in London, about 35 billion in securitized assets. So the growth has been been really nice over the last 14 years that I've been here.
CJ Doherty: OK great. Can you now talk about how the CLO ETF market has grown in the last couple of years? You know what have been the drivers and can you put some numbers around this growth for our listeners? And also how does this compare it to....How does this growth compare to other credit ETF categories?
John Kerschner: Yeah, sure. So we launched our first CLO ETF, J AAA or JAAA is the ticker back in October of 2020 coming out of the COVID crisis. And then we launched our second CLO ETF, J triple B in January of 2022. If you went back two years from now to about August of of 2022, those two combined were only about 1.5 billion. So decent growth, but not nearly where we are today. If you went back a year ago, those two combined would be just under 4 billion. So in a year, we almost tripled in size from about 1 1/2 to four, and we're sitting here today, those two ETF's are about 12 just under, actually just under 13 billion. So, almost another tripling more or less over the last year. Now J AAA is much bigger. It's just under 12 billion, but J triple B now is is over a billion, so really good growth and we think actually that's gonna continue. I think it's very interesting when you look at some of the other credit ETF out there. If you look at like the leveraged loan ETF's BKLN or SRLN or the two large ones, and you go back to 2020, they were about 5 1/2 billion combined. Today, they're almost 13 billion combined, so over 100% growth, whereas the other credit ETF's, if you look at high yield like HYG or JNK two of the bigger high yield ETF's, have actually shrunk over that time from 2020 till today by about 40%. Back then, they were about 37 billion. Today they're about 24 billion. And then if you look at one of the big investment grade ETF LQD back in 2020, it was about 55 billion and now it's about 32 and change billion. So both high yield corporate credit and investment grade corporate credit ETF have actually shrunk about 40%. So the trend has been lot more in ETF. So although starting from a very low base, obviously more in leveraged loan, ETS probably has something to do with their floating rate nature like CLOs over the last couple of years. But other credit ETF's have actually shrunk, and I don't really have a great answer why those, why there's been some shrinking in those other ETF S besides the fact that maybe dollars are going into some of these newer ETF.
CJ Doherty: OK. Yeah, that that's certainly impressive growth on the CLO ETF side and following on from that, what is investor demand like for CLO, AAA note ETFs compared to triple B ETF?
John Kerschner: Yeah. So it's it's a very different client base, I would say the AAA obviously incredibly safe. It's it's in, except for securitised markets is very difficult to find AAA type credits. Even the US is not really considered a AAA credit anymore. There's only two corporate credit names, Microsoft and Johnson and Johnson, that are AAA. So I think people have obviously been attracted to the floating rate nature and the high yield, but also the you know the the safety that comes with the AAA rating, J triple B we launched, like I said in January of 2022, one month before Russia invaded Ukraine. So little inauspicious timing there, but obviously we didn't know that was gonna happen. But I think what also was going on in 2022 is you recall in in your listeners recall lot of economic forecasters were calling for a recession back then and so it gave people some pause. I think we can convince people that triple B CLOs are are very default remote but obviously a recession would would cause some volatility in any kind of credit or risk assets and so people wanted to see that ETF grow and have a track record. But now what we're seeing, particularly in 2024, is more money coming into J triple B, not more than J AAA. But whereas before in J triple B, maybe we're bringing in 10 to 25 million a month. This year so far, we've been taking in more like 100 million a month and and I think that's because more people are convinced that the Fed is on the right side of what they're trying to do with the economy. Soft landing seems to be the base case for most investors, so J triple A still much bigger, still growing faster.Bigger investor base simply because it's a simpler story with the high credit quality. But J triple B actually taking in a decent amount more and a lot more than we were taking in a last year in 2023.
CJ Doherty: OK, got it. Uh, and given the background that you described so far, So what impact are CLO ETFs having on the CLO market overall and also in what way are they impacting the CLO secondary market?
John Kerschner: Yeah, we've been getting this question a lot, CJ, because people say, wow, you've, you know, you've grown, you're you're almost a a 13 billion plus or minus the CLO ETF combined market is about close to15 billion.
That seems like, you know, a huge driver of growth and helping technicals and and maybe driving spreads and prices, right? But I think people have to realize that the CLO market the US CLO market is a trillion dollars. And then there's a European CLO market as well, that's another 250 billion. It's a massive market and you combine US and European CLOs they're almost as big as the high yield corporate credit market here in the US so and if you think about who owns CLO, particularly AAA, CLO banks own about 200 billion Japan, that's U.S banks Japanese banks owned around another 80 billion, money managers in the US own somewhere around 200 and 250 billion, insurance companies are big buyers. So when you start looking at these big buyers of the hundreds of billions, you know, 15 billion of ... of the ETF by market, it's not nothing, it's still matters, but it's not as huge as some of these other kind of traditional buyers. So I think we're moving the needle a little bit as the CLO ETF market is. We're obviously definitely helping the technicals, but we're not really the big 600-pound you know gorilla out there, that's still US money center banks and the money manager community. And and we have a long way to go as far as the ETF market to kind of compete with them as far as buying.
CJ Doherty: OK. And now let's pivot a little bit. John, you have a number of securitized ETF's in your product suite aside from CLOs. Where are you seeing investor interest there?
John Kerschner: Yeah. So actually our first securitized ETF launched back in 2018 was JMBS, focuses mostly on agency mortgage backed securities, but also a bucket of non agency as well. The idea with that product was when we launched it, there was no actively managed mortgage backed security ETF in the US, which was a huge surprise to me because I had been actively managing mortgage backed securities in, you know, 40 act funds since in the mid 90s. And I've never heard a good reasoning why agency mortgage backed securities shouldn't be actively managed. It's a very liquid market, probably the second most liquid fixing to mark in the world after U.S. Treasuries, but very inefficient because mortgages, given their prepayment risk and and their cash flow variability are fairly complicated, take a lot of people and modeling and data. And so what we said is we can offer our product with the liquidity transparency tax advantage, the relatively low fee of the ETF market to the you know, the masses, both institutional and and retail. That now that product is about four and a half billion. Given the the success of that like I mentioned, we met, we launched J AAA in October 2020. J triple B and January of 2022. But our latest offering, and actually it's been our fastest growing out of the box securitized ETF is JSI or Janus Henderson securitized income and the idea behind that is even with those three other ETF's, there's still a wide range of securitized products, basically asset backed securities, commercial mortgage backed securities and and and focusing more on the non agency mortgage backed security market that weren't addressed in our other offerings.
So we focus on those. We also have a small bucket of AAA CLOs and agency mortgages in that product. But the idea was this gives investors who don't necessarily want to be in a floating rate product access to be very what we consider a very cheap market in securitized products. Still, about 75% investment grade, so fairly high credit quality and still fairly high yield that it 7.5% yield. But you're accessing these these securities that really aren't reflected in some of the big indices like the Bloomberg Barclays Aggregate Index Agency. I'm sorry ABS and CMBS are only 2% approximately of that index. So it really allowed us to kind of broaden the universe for securitized proxy ETFs and there's really no other product out there in ETF land that does the same thing at a scalable rate. So you have a specific product in JMBS, if you want mortgage exposure 2 products, if you want CLO exposure and now our latest product offerings about 350,000,000 JSI, which gives you basically mostly investment grade, very high yielding access to the other parts of the securitized market, which combine our about 5 trillion totals, so very large market.
CJ Doherty: OK. So when you're in your opinion, how compelling is the US securitized market compared to corporate credit these days?
John Kerschner: Yeah. Well, let me just preface my answer by saying I'm very biased. I I had securitized products here in the US and at Janus Henderson. But but if you just look at the data right and one way people look at this is compared today's spreads with what we've seen historically like go back to 10 last 10 years, right? Not necessarily. Just a year or two years or five years. But let's go back ten years. You could go back to the GFC 2008, 2009 if you want it be the same thing and what you see with securitized products is there about the middle of that range. CLOs are a little tighter, which aren't. It's not really a surprise cause CLO have become a lot bigger and and and bought by more investors over the last 10 years. But even a BS and and CMBS and agency mortgages around kind of the middle of the range spread wise versus corporate credit whether IG or high yield, it's kind of the bottom decile spreads or the tightest spreads we've seen over the last 10 years and and some of that has to do with the soft landing scenario that I outlined. But what really happened is since COVID happened and the Fed came out and supported, you know the US Treasury market and and support the agency mortgage market, but also supported the investment grade corporate credit market and even offered to buy a high yield corporate ETF. They did nothing really, the Fed did nothing for the rest of the securitized market and so securitized products has taken a long time since COVID happened to kind of recover. We had, you know, 2021, which was huge issuance and 2022 was bad technicals with more issuance and money managers were getting withdrawals because interest rates were going up. And it really is only been in the last 6-8 months where the technicals have really turned and been positive for securitized products and so the spreads have come in some but not nearly as far as they have in securi..in in corporate credit. So most people look at securitized products now and say, you know, spreads are very attractive. And then one other important thing is most securitized products are issued at the short end of the yield curve between one and five years. And now that the yield curve is inverted, meaning the short end has higher yields than the long end, that makes the overall yields of securitized products look very attractive versus other fixed income and that's why we can launch JSI or our newest ETF and get that kind of 7.5% yield with still 75% investment grade. And you know, basically two to three years of of duration. So based on all those factors, we think securitized products are incredibly attractive right now.
CJ Doherty: OK, John, so just to add on to what you said there, final question here. There is now an expectation in the US of a shift in monetary policy is now the time to lock in some level of duration ahead of the Fed cutting rates.
John Kerschner: Yeah, that's so this is a difficult question because no one really knows where interest rates are going. I agree that the Fed is very likely to cut interest rates in the in their next meeting in September. The the issue is that the markets are front running that right, they're expecting that. So if you think about where the 10 year Treasury yield has gone, if you go went back last October, was that 5% in April was at about 4.7% currently about 3.8%. So the long end of the yield curve has already rallied a lot an expectation of cuts and what the market is telling you is like a three month T bill in the next two years is gonna go from about 5.15% down to kind of the mid 3.5%, mid 3%, something like that. But the market is telling you the 10 year over that time will actually go up in yield a little bit. So that's the normalization of the yield curve. So what we tell investors is either have exposure to all the yield curve, like all parts of the yield curve, short, medium and long, because if we do go into a hard landing that long and will come down some more. But you don't wanna take all your eggs out of the short end of the yield curve and put them in the long end because that was the trade kind of for late 2023 and a lot of that trade is already played out. Keep some of your exposure to the short and the yogurt again. Why we like securitised products right now.
CJ Doherty: Great. And with that, we will wrap up for today. John, thanks very much for shedding light on Cielo ETFs and the broader securitized market.
John Kerschner: Thanks CJ. I really enjoyed it.
CJ Doherty: And thank you all for tuning in. I invite you to check out our CLO and loan market news data and analysis at loanconnector.com. Follow us on X at lpcloans. I'm CJ Doherty, subscribed to the lending lowdown on your favorite podcast platform.
