Bond yields remain elevated. But many income investors want to access strong income streams with reduced credit or interest rate risk. One way to accomplish that is with collateralized loan obligations (CLOs).
The asset class is accessible via exchange traded funds, including the VanEck CLO ETF (CLOI). The actively managed fund, which debuted in June 2022, has quickly gained traction among advisors and investors. That is highlighted by an assets under management tally of $422.77 million. That’s good work for an ETF barely more than two years old.
A 30-day SEC yield of 6.72% certainly helps. That’s higher than what investors earn with money markets, Treasuries, and some corners of the corporate bond market, among others. Those comparisons are relevant. That’s because CLOs, particularly middle market collateralized loan obligations (MMCLOs), stack up well against other high yield asset classes.
CLOI Could Be Strong Income Bet
Typically, investing in fixed income instruments requires investors to make a trade-off. Higher yields are easily accessible. But those are usually attached to longer duration bonds or issues with lower credit quality. Said another way, high yields usually come with credit or interest rate risk.
With a duration of 3.92 years and with more than 86% of its holdings carrying investment-grade ratings, CLOI mitigates some of the credit and rate risk typically associated with high-yield assets. In fact, some experts believe MM CLOs currently compare favorably to business development companies (BDCs). MM CLOs feature safeguards that could make the asset class attractive to risk-averse income investors.
“MM CLO structures relative to BDCs generally include stricter and more conservative collateral eligibility requirements, cash diversion features allowing for priority repayment of higher rated tranches, an absence of liability refinancing risk and lack of sensitivity to frequent changes in asset valuations,” according to Fitch Ratings. “Higher CLO ratings are also supported by declining leverage, given amortization requirements after reinvestment periods, and a view into portfolio company credit opinions.”
Fortifying the case for CLOI, which has some MM CLO exposure, are the assets held by MM CLOs and the diversification traits offered by the corner of the CLO market. The VanEck ETF is actively managed, so the potential exists for increased MM CLO exposure over time.
“There can also be a meaningful difference in the seniority of the assets in a MM CLO versus those in a BDC. MM CLOs consist almost exclusively of first lien senior secured loans, while BDCs can invest all the way down the capital structure. The level of portfolio diversity can be another differentiating factor with regard to asset quality,” concluded Fitch.
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