CLOs Look Sturdy Even as Junk Defaults Rise | ETF Trends

A recent surge in bankruptcies and defaults by high-yield issuers is unnerving some fixed income investors. Bond investors, particularly those seeking elevated levels of income, are rightfully jittery. Still, there are some potential refuges in the high-yield landscape. Those include collateralized loan obligations (CLOs), which are accessible via a small number of dedicated exchange traded funds. That group is led by the VanEck CLO ETF (CLOI).

Home to nearly $161 million in assets under management, CLOI debuted in June 2022. As of Oct. 12, the VanEck sported a tempting 30-day SEC yield of 6.52%. This is well above what investors find on 10-year Treasurys, and some high-yield corporate debt ETFs.

CLOI Worth Considering Today

Experienced bond investors know that in standard operating environments, the usual tradeoff is accessing above averages while taking on elevated credit risk. Fortunately for investors considering CLOI, the ETF mutes credit risk.

Some analysts view CLOs courtesy of US-based issuers and those in the Europe, Middle East and Africa (EMEA) region as surprisingly sturdy, affirming this point.

Fitch applied EMEA- and US-specific stress scenarios that incorporated immediate defaults to loans in the first and second MCL tiers, and three-notch downgrades to loans in the third MCL tier,” noted Fitch Ratings. “Further stress was applied based on region-specific assumptions. Under these stress scenarios, the overwhelming majority of ‘AAAsf’ rated notes from both regions remained stable. The sub-investment-grade tranches of non-reinvesting CLOs were most vulnerable in these scenarios: more than three-quarters had a model-implied downgrade.”

In other words, bad to worst-case scenarios for the lowest-rated CLOs would likely result in credit ratings downgrades. This implies credit quality is a primary consideration for investors mulling this asset class. That highlights the benefits of CLOI because more than 93% of the ETF’s rated holdings carry grades of AAA, AA, or A. That’s a positive attribute in any environment, espcially one where junk CLOs may fall out of favor.

“Most US and EMEA ‘AAAsf’ rated tranches were unaffected, 85% and 80%, respectively, under the global stress. Although more ‘AAAsf’ ratings are subject to an implied downgrade under the global stress compared with the more granular regional stresses, the impact is limited to one notch for most of the affected ‘AAAsf’ notes,” concluded Fitch.

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