Consider CLOs for Credit Quality, Income | ETF Trends

Collateralized loan obligations (CLOs), which are securitized pools of leveraged loans, have long been the territory of professional traders and hedge funds, but thanks to exchange traded funds, the asset class is now accessible to investors of all stripes.

The VanEck CLO ETF (NYSE Arca: CLOI) is certainly part of the discussion. CLOI, which debuted in June, is one of this year’s more interesting rookie ETFs, particularly for investors looking for income without embracing more risk.

CLOI holds 18 CLOs and is a relevant consideration for income-starved investors at a time when active managers in this asset class are looking to boost portfolios’ credit quality.

“U.S. CLO managers are boosting the credit quality of their portfolios as they position CLOs to weather recessionary pressures and other headwinds affecting corporates, such as supply chain issues and high energy prices,” noted Fitch Ratings. “Initial portfolio credit quality for new issue deals has strengthened, as measured by lower Fitch weighted average rating factors (WARF) and increased credit enhancement (CE) across the capital structure.”

CLOI is actively managed and features stout credit quality as more than 85% of its holdings carry investment-grade ratings while the remainder isn’t rated. Of that 85%, more than three-quarters are rated AAA or AA, according to issuer data. That’s a positive because CLO investors typically look to skirt risk, not embrace it.

“CLO investors are more risk averse and not only expect better-positioned portfolios to weather a downturn but also a higher level of protection and compensation. CE across the CLO capital structure increased since February, with CE for senior ‘AAAsf’ rated notes issued in August up over 1% and CE for ‘BBsf’ classes increasing over 2%,” added Fitch.

There are some signs CLO managers are willing to go down the ratings scale to find opportunities, but they remain unlikely to probe the lowest credits.

“Other metrics indicate some risk-on sensitivity but not as much as what was seen in 2020. The average reinvestment period for CLOs with a reinvestment period is currently 4.4 years for deals done through the start of September, compared with 4.9 years in 2021 and 3.5 years in 2020. The maximum WAL, so far this year, is 8.6 years, down from 9.0 years for deals done in 2021 but less than 8.0 years in 2020. More significant variability in reinvestment periods have been observed between deals this year,” concluded Fitch.

As for CLOI, it maintains stout credit quality while offering a 30-day SEC yield of 4.21%.

For more news, information, and strategy, visit the Beyond Basic Beta Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.