Luxembourg has been outpaced in the development of exchange-traded funds by Ireland. However, steps have been taken to improve Luxembourg’s offer. Investment Officer has spoken with people involved in the recent launch of a new Luxembourg-domiciled Ucits-compliant collateralised loan obligation (CLO) exchange-traded fund (ETF), which benefits from two-year-old changes to Luxembourg’s securitisation law.
Fair Oaks Capital announced the exchange listing of the first European AAA CLO ETF, Fair Oaks AAA CLO ETF, on 11 September. It was launched as an additional listed share class of an existing Fair Oaks Ucits fund: ‘Fair Oaks AAA CLO Fund’, launched in 2019 on the same platform with over 150 million euro in assets under management at the end of August 2024.
The CLO ETF fund has a total expense ratio of 0.35 percent.
“We consciously chose Luxembourg, and I remember our advisors - they told us, look, it’s going to be a long process. Luxembourg, obviously, is very detailed,” explained Miguel Ramos Fuentenebro, one of the co-founders of Delaware-based Fair Oaks Capital and co-leader of the ETF fund’s management team. They have a reputation to uphold. You will be referred to different departments within the CSSF because this is a new asset class.”
Really wanted
Rather than seeing this as a problem, “we thought that that’s really what we wanted if we are asking investors to look at an asset class that is new, that potentially has a perception of complexity. We want to make sure that the first reaction is to look at where we have domiciled the fund and feel comfortable that we haven’t taken any shortcuts,” Fuentenebro explained.
It’s clear that for Fuentenebro, the fund’s main feature is that it gives investors access to the CLO market. He is a big fan of the securitisation vehicle.“We did not think about ETFs until we saw the growth of this product in the US,” he said.
This gave Fair Oaks “the opportunity to think about why people were investing in ETFs when they have the possibility to invest via funds,” Fuentenebro explained. “And I think we did realise that there’s a number of investors for multiple reasons that will not invest through a Ucits fund, either because their investment policies do not allow them, they are supposed to invest in securities, or because they have a tax preference for ETFs.”
Targeting subset
Realising that their 2019 CLO fund was “targeting a subset of the investor universe,” and “missing a potential subset which could be accessible via ETFs,” he explained – “that’s the moment when we started exploring whether that’s something we could replicate in Europe.”
Luxembourg law firm Elvinger Hoss Prussen was involved in obtaining regulatory approval for the fund, with partner Yves Elvinger playing a leading role.
“Luxembourg domiciled UCITS funds can invest up to 100% of their assets in CLOs, provided that they are eligible and subject to certain restrictions”, Elvinger explained.
“We had very constructive exchanges with the regulator on the applicable requirements,” Elvinger said. “One of the main challenges in setting up a CLO UCITS ETF was related to restrictions on distributions, given they are listed on the stock exchange, and how to make sure shares are offered to the defined target market.”
Detailed understanding
Fair Oaks has not yet established a target for the ETF fund as it is still new, explained Fuentenebro.
“What we have seen is that very often investors like to understand the product in detail and we are very, very keen to do that,” he said, explaining that the firm has launched a fund website and plans to publish a few white papers on the CLO market, on the opportunity.”
Fuentenebro underlined the importance of the CLO component in his earlier fund.
Filling a gap
“The point of the fund was to effectively fill a gap in the European market,” he said. “If you look at the options that investors have in Europe, there are very few floating rate assets, especially highly-rated floating rate assets.”
“From a financial allocation perspective, there are times where investors really don’t want to take that interest rate exposure and offering them a product that had that fundamental robustness, and at the same time, an attractive spread, was a compelling option,” he explained.
According to Fuentenebro, rating agency data on CLOs since 1997 has shown “there has been not a single default of a triple-A CLO.”
Special purpose
Luxembourg updated its securitisation law in 2022 to enable active management of CLOs with new types of special purpose vehicles.
In 2022, Luxembourg enabled the active management of CLOs through an update to its 2004 securitisation law.
Luxembourg’s government has made an eventual reduction of the tax burden on actively managed ETFs a key policy initiative. In Ireland, Luxembourg’s chief rival, actively and passively managed ETFs enjoy equal treatment.