BMO AAA CLO ETF (ZAAA-F): A Rising Rate Dividend Machine?

The BMO AAA CLO ETF (ZAAA-F) has emerged as a compelling income generator in a challenging market environment. Recently declaring a monthly dividend of CAD 0.134, the ETF offers investors a way to capture yield in an era of rising interest rates. But how does it stack up against other income vehicles, and is its appeal worth the risks?

The ETF's Structure: A Floating-Rate Play

The BMO AAA CLO ETF invests in senior secured loans backed by collateralized loan obligations (CLOs), which are typically rated AAA. These loans carry floating interest rates tied to benchmarks like LIBOR or SOFR. In a rising rate environment, this structure is a key advantage: as central banks hike rates, the interest income from these loans increases, potentially boosting the ETF's distributions. This contrasts sharply with fixed-rate bonds, which lose value as rates climb.

Yield Analysis: A Competitive 5.3%

With a current price of CAD 30.19 (as of June 19, 2025), the ETF's monthly dividend of CAD 0.134 translates to an annualized yield of 5.3%. This compares favorably to the Canadian 10-year government bond yield, which hovers around 4.2%, and the U.S. 10-year Treasury yield of 4.5%. The ETF's yield is also competitive with high-dividend equity ETFs, such as the SPDR S&P 500 High Dividend ETF (SPYD), which offers a 4.5% yield but lacks the interest rate sensitivity of floating-rate loans.

Pros of the ETF in Rising Rates

1. Rate-Hedged Income: Floating-rate loans adjust with short-term rates, meaning the ETF's distributions could rise alongside the Bank of Canada's hikes.
2. Monthly Payouts: Consistent income for retirees or income-focused investors.
3. AAA Credit Quality: The ETF focuses on top-tier CLO tranches, reducing default risk compared to lower-rated loans.

Risks to Consider

• Credit Risk: Even AAA-rated CLOs face defaults if underlying borrowers struggle. The energy and real estate sectors, which make up much of the CLO market, could be vulnerable in a prolonged economic slowdown.
• Liquidity: While the ETF is listed on exchanges, the underlying CLOs may have limited secondary market liquidity, potentially leading to price volatility.
• Currency Risk: The “Hedged Units” designation means BMO actively manages currency exposure, but hedging costs could eat into returns.

Investment Takeaways

For income-seeking investors who can tolerate moderate credit risk, the BMO AAA CLO ETF offers a compelling alternative to bonds. Its floating-rate structure positions it to benefit from further rate hikes, and its 5.3% yield provides a solid cushion against inflation. However, this ETF is not a “set it and forget it” play. Investors should:
- Monitor the health of the underlying loan portfolios.
- Compare its yield to shorter-term bond alternatives, like 2-year government bonds (currently yielding 5.0%).
- Consider diversifying income streams with equity ETFs or REITs to balance risk.

Final Verdict

In a rising rate world, the BMO AAA CLO ETF is a compelling, if niche, income generator. While not without risks, its structure and yield make it a worthy consideration for investors willing to navigate credit markets. Just remember: even AAA-rated debt isn't foolproof.

Investment Advice: Consider a small allocation to ZAAA-F as part of a diversified income portfolio, but pair it with safer assets like short-term bonds to mitigate risk.