The Mechanics of the ETF Market 

With the advent of the Exchange Traded Fund (“ETF”) market in the early 1990s¹, ETFs have continued to proliferate with assets reaching over US$4.3 trillion as of June 30, 2020.² The ETF space has thrived since their introduction largely driven by lower expense ratios, diversification benefits, increased liquidity, access into previously restricted markets, dynamic intraday trading and ease of use.

ETFs trade like publicly-listed stock on an exchange. ETF shares can be bought and sold throughout the day, with the price of the ETF likely to fluctuate as demand waxes and wanes. In some cases, where there is ample liquidity and sufficient market interest, listed option contracts can also be available on the underlying ETF. 

The mechanics of issuing ETF shares differ from a mutual fund in that an ETF is not issued or redeemed at net asset value (“NAV”) by individual investors. Instead, as demand and supply increases and/or decreases, shares are either created or redeemed by an Authorized Participant (“AP”) in large blocks of what are called ‘creation units’. APs are customarily large financial institutions like Bank of America, Citibank, JP Morgan and Wells Fargo, to name a few. 

Illustrative In-Kind and Cash Creation and Redemption Processes

Creation units are generated through either an exchange of in-kind assets or with cash. The assets that can be utilized for in-kind creation or redemption of ETF shares are determined by the ETF’s manager each day and are often a reflection of the assets already held in the portfolio. Many managers have some discretion to create or redeem baskets in all cash as well, if appropriate. Every new creation unit increases the assets under management (“AUM”) of the ETF and conversely, every redemption reduces AUM. The daily NAV of an ETF is typically published after the close of business once final pricing of the underlying assets is checked and validated by a third party.

The dynamic process of creation and redemption of shares help regulate the price of an ETF from deviating too far from its NAV. For instance, if the share price increases dramatically above the NAV for whatever reason (referred to as “trading at a premium to NAV”), investors are likely to create new  units which would generate additional shares, have a dilutive effect (all else being equal) and bring the share price back closer to the NAV.

Proposed Daily Unit Creation and Redemption Schedule 

A AAA-rated CLO ETF

In many ways, the broad characteristics of an ETF focused on AAA-rated collateralized loan obligations (“CLOs”) would be analogous to a credit-focused ETF like ticker symbol ‘JNK’, which concentrates on very liquid, high yield bonds³ and have been actively trading for several years. The difference would be that a AAA-rated CLO ETF manager would focus on the most senior liability in the CLO capital stack and in turn would have a read through to the broadly syndicated, floating-rate corporate loan market. Broadly syndicated corporate loans that qualify for inclusion into CLOs are generally required to have first lien positions, satisfactory ratings requirements, be secured by collateral and have minimum deal sizes.

A AAA-rated CLO ETF should be attractive to a host of investors, including dedicated institutional investors managing risk across a spectrum of asset-backed investments who could potentially utilize a publicly-listed AAA-rated CLO ETF to help manage liquidity and relative value positions; regional insurance companies and smaller financial institutions that have incremental demand for investment grade products but are shut out of the primary CLO market; and retail investors seeking potentially higher relative yields in the investment grade credit universe.  

Credit-focused investors should always consider other important factors associated with all ETF investments which include: i) the management approach, with ETF managers employing either an active strategy or a passive one ii) the distribution schedule, which are commonly monthly, quarterly or annually iii) the quality of underlying assets.

Contact Information:

Todd Themistocles

Email: tthemistocles@altacfunds.com

Phone: 917-535-5737

Disclaimer:

The fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the investment company, and once available a copy may be obtained without charge, by calling the Fund at 1-800-617-0004. Read it carefully before investing. 

The fund is currently not available for investment.

Diversification does not assure a profit nor protect against loss in a declining market.

Investing involves risk. Principal loss is possible. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV, and are not individually redeemed from the funds. Brokerage commissions will reduce returns. 

The Fund is also subject to the following risks: Collateralized Loan Obligations (CLOs) are generally backed by a pool of credit-related assets that serve as collateral. Accordingly, CLO securities present risks similar to those of other types of credit investments, including default (credit), interest rate and prepayment risks. In addition, CLOs are often governed by a complex series of legal documents and contracts, which increases the risk of dispute over the interpretation and enforceability of such documents relative to other types of investments. An increase in interest rates may cause the value of fixed-income securities held by the Fund to decline. The Fund may be subject to a greater risk of rising interest rates due to the current period of historically low rates and the effect of potential government fiscal policy initiatives and resulting market reaction to those initiatives. The Fund’s income may decline if interest rates fall. 

The Fund is a recently organized, diversified management investment company with no operating history. Additionally, the investment adviser has not previously managed a registered fund, which may increase the risks of investing in the Fund.

The AAF First Priority CLO Bond ETF is distributed by Quasar Distributors, LLC. 

Footnotes:

¹ “The History of Exchange-Traded Funds”, www.etffguide.com.

² New York Stock Exchange market statistics release June 30, 2020.

³ SPDR Bloomberg Barclays High Yield Bond ETF, Factsheet.