The number of US-centric CLO ETFs surged during 2024, and now Europe is poised for growth too.
LFI spoke to Palmer Square’s Jeremy Goff (managing director) and Taylor Moore (managing director and portfolio manager) about the upcoming launch of the firm’s three new ETFs in Europe.
They discuss motivations for launching CLO ETFs, asset selection for both the passive and active funds, and projections for growth in the sector.
Q: Why is Palmer Square launching CLO ETFs in Europe?
Taylor: ETFs are a natural progression for the CLO market in Europe, which has now grown to over €250bn with an established investor and issuer base. The funds follow the launch of our Euro CLO debt indices in 2024.
We’re launching two passive UCITS CLO ETFs in Europe: one mirrors the assets in our Euro CLO senior index [ticker: ECLOSE] and the other the assets in our US CLO senior debt index [ticker: CLOSE].
The third ETF will be an active, multi-asset fund that invests across the CLO debt stack (AAA to BB), leveraged loans, corporates and IG ABS.
Allocations to each asset class will depend on where we see the best relative value, and we have flexibility to invest purely in one specific asset class if that’s the best proposition.
All three funds are targeting launch by the end of Q1.
Q: What will the ETFs’ AUM be at launch, and what are your projections for growth?
Taylor: We envisage each fund will launch with a strong level of seed AUM. We’re having conversations with authorised participants in Europe about seed investments and have a number of potential partners for investments across all three funds.
We’re anticipating good demand for our funds and, given the growth in the US CLO ETF market, I wouldn’t be surprised if combined European CLO ETF AUM is above €1bn by this time next year.
Q: How do you select assets for the passive European CLO ETF?
Taylor: Most of our purchases will be made on the secondary CLO market, as the ETF’s constituents mirror the assets that are in our senior CLO index. The index gets rebalanced quarterly, so it’s possible that we will buy in primary in these instances.
We limit investments to a subset of the most liquid part of the market, which accounts for ~40%-50% of the entire European CLO market. Each manager has to have at least two deals under management.
Unlike other European CLO ETFs, there will also be a component of Double A CLOs in both passive ETFs, but less than 20% of the total exposure.
Q: How do the passive funds respond to inflows, given the high number of assets they reference?
Taylor: When the passive funds receive inflows, it’s not possible to buy exposure to every bond referenced in the index as there are too many.
We would therefore buy a representative sample, eg. by manager, vintage, coupon, to try and closely match the overall profile of what’s in the index.
Q: In which jurisdiction will the CLO ETFs be established, and why?
Jeremy: The ETFs will be registered in Ireland, and that decision was largely driven by personal preference. The jurisdiction has an established ecosystem for ETFs and CLOs alike, and the existing relationships we have make it more efficient to register our funds there.
The Central Bank of Ireland (CBI) became comfortable with 100% CLO ETFs around the time we were drawing up plans, so timing also played a role.
Q: What are the main challenges you faced in establishing CLO ETFs in Europe?
Jeremy: European regulators are new to the idea of putting CLOs into liquid wrappers, so they are inevitably more cautious. We have to make sure we’re targeting the right set of buyers (i.e. institutional or professional) and need to create barriers that prevent retail investor interest.
For example, within the UCITS that these funds will be launched in, there will be minimum investments of €125,000, which be a natural guardrail against retail investments. From a marketing perspective, we’re purely targeting institutional and professional investors.
Q: How might CLO ETFs react in times of market volatility?
Taylor: Liquidity in CLO Triple As has increased significantly in recent years, and as a result we think CLO ETFs are ready to handle any periods of stress, particularly at the top of the stack.
During the UK LDI crisis in 2022, money managers discovered that CLOs were the most liquid instruments they had and used them to raise cash quickly. That’s a good case study for CLOs in periods of volatility.
Jeremy: To some degree, periods of volatility are good for ETFs because it shows the regulators how the instrument behaves in times of stress, so they can get more comfortable with the product.
Q: Do you plan to launch a mezz-focused CLO ETF in Europe?
Taylor: Even though the European CLO market has grown and gotten more liquid, it’s still a little early for a purely mezzanine CLO ETF in Europe. But it’s certainly something that we’ll look at in time.
Anna Carlisle
anna.carlisle@levfininsights.com
+44 (0)20 7469 0981
