AAA - AAF First Priority Bond ETF

[thepupil]

This ETF started trading today; there was a hype story on bloomberg about retail getting a piece of the CLO market and everything.

 

when i read this, i literally said to myself "i have always wanted to be able to invest in CLO AAA". I am not kidding. I promise I am fun at parties.

 

This is not an exciting investment, but I think it's worth keeping track of for those who are into this kind of thing (all 2 of you).

 

AAA owns AAA tranches of CLO's. it charges 30 bps.

 

CLO AAA is the top of the capital structure in leveraged loans. it's the 0-60% tranche So take 100 loans issued by the likes of Berry Global or Neiman Marcus or XYZ PE company and put them in a securitization. to simplify it, if 40% of those loans default with 100% severity, then you may lose money on the AAA. in the other 99.8% of scenarios, you just clip your coupon. For some perspective, a few CLO AAA tranches were sold by forced sellers in March 2020, at decent losses. the index on bloomberg widened from 100-->260 spread and that was considered craziness.

 

I hate loan risk, credit quality is truly terrible theses days, but I think CLO AAA will be okay, in all but the Mad Max scenario.

 

Currently, the AAA index indicates that AAA trades for about L+130. So after fees this ETF should provide you with L+100. obviously that's not great right now because of the L part of the equation.

 

For some perspective the Vanguard Intermediate investment grade yields 1.4% 1/ a duration of 6 and short term IG yields 1.0%, with a duration of 2.

 

CLO AAA has no duration and currently yields a similar amount to the intermediate term type of stuff.

 

I am keeping track of this for a few reasons.

 

1) as an arrow in the quiver for a diversified pool of cash and high quality fixed income as part of a retirement portfolio. this is floating rate super senior paper that has minimal risk of permanent impairment. if rates wen up some, may not be a bad way to make 2-3%, again for those who manage a portfolio of cash + and other bond type stuff. I don't fully understand the whole "illiquid assets in a liquid ETF" thing, so one could never make it a large portion of said portfolio. if i understood this risk better, I would like CLO AAA as a decent chunk of the cash/FI portion.

 

2) I suspect that this ETF may have  higher volatility than it should, that it may get weird and trade all crazy like in times of credit volatility; it could make for a good trading vehicle.

 

3) it has a cool ticker

 

 

 

[BG2008]

Pupil,

 

Love your inputs

[ActOfWill]

Thanks for highlighting.

 

During my travails to buy listed forms of US/EU CLO equity earlier this year I found the following interesting:

 

https://www.guggenheiminvestments.com/perspectives/portfolio-strategy/collateralized-loan-obligations-clo

 

Which shows that AAA CLOs have not suffered any defaults (impairment of principle) since 1994. Don't worry I don't work for a rating agency...

 

As to the "risk" / opportunity side of the equation; the market clears via Bids Wanted In Competition (BWIC or "BWICs") which are an OTC form of organising an ad hoc auction, typically between dealers and hedgefunds.

 

Data is available but only of the "cover" i.e. the best non-winning bids.

 

Second picture shows you how the repo/cash crunch in March this year drove prices around (source: Creditflux).

 

3) it has a cool ticker

 

Flashback to Amsterdam listed Apollo Alternative Assets LP

[thepupil]

thanks! wow i didn't know AAA was covering in the mid 70's for a week, that's wild!

 

 

As to the "risk" / opportunity side of the equation; the market clears via Bids Wanted In Competition (BWIC or "BWICs") which are an OTC form of organising an ad hoc auction, typically between dealers and hedgefunds.

 

yea, this is what concerns me a little bit; i used to trade a high quality securitized product and there are times where it's just not liquid, could be for the simple reason that my boss was on vacation/off the desk and 23 year old pupil is bidding things 1 point conservative, or that there's a massive global liquidity squeeze and CLO AAA is down 20 points.

 

but the likes of JNK and more comparably BKLN have seemed to do fine over time (of course AAA needs to get a little bigger before once could compare to these).

 

there is nevertheless a potential liquidity mismatch. you'd hate to lose 5-10 or more points on your super safe AAA paper because of some ETF/marketweirdness.

 

relevant portion of the prospectus

The Fund intends to effect its creations and redemptions primarily for cash, rather than in-kind

securities. Paying redemption proceeds in cash rather than through in kind delivery of portfolio securities may require the Fund to

dispose of or sell portfolio investments at an inopportune time to obtain the cash needed to pay redemption proceeds.

[ActOfWill]

there is nevertheless a potential liquidity mismatch. you'd hate to lose 5-10 or more points on your super safe AAA paper because of some ETF/marketweirdness.

 

relevant portion of the prospectus

The Fund intends to effect its creations and redemptions primarily for cash, rather than in-kind

securities. Paying redemption proceeds in cash rather than through in kind delivery of portfolio securities may require the Fund to

dispose of or sell portfolio investments at an inopportune time to obtain the cash needed to pay redemption proceeds.

 

An "illiquidity-doom-loop" would definitely be a great future buy opportunity on the underlyings of the ETF; on buying the ETF itself, you need to be certain of some ultimate money printing by governments - which is always easier to see in retrospect.

 

This March the loop lasted 3 weeks until the FED flooded the market, ~6% discounts on some of the large IG/HY ETFs at the peak (18 March).

 

https://www.bloomberg.com/news/articles/2020-03-20/mizuho-charts-roadmap-for-an-illiquidity-doom-loop-in-etfs