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In the midst of a Fed rate-cutting cycle combined with robust economic growth and rising long-term bond yields, William Sokol explores opportunities and challenges for income investors. He reviews our income investing outlook focusing on how this dynamic environment calls for selective strategies, focusing on higher-quality investments like CLOs and attractively valued corporate bonds.
For more, read our Income Investing Playbook blog.
Income Investing in a New Rate Cycle: Seek High Quality, Attractive Value
We've entered 2025 in the middle of a Fed rate cutting cycle. This is the first time we've seen this since 2019 and COVID and before that the GFC, but this time is a little bit different in that we're seeing the Fed cutting rates while we're also seeing robust employment and economic growth. Those factors, and others, have resulted in a significant increase in bond yields even as the Fed has continued to lower the policy rate.
2025 Income Investing Outlook
And this does present opportunities, but also challenges for income investors as we look ahead into the new year. On the one hand, bond investors can lock in attractive yields and earn meaningful income from their bond portfolios.
However, rising long-term bond yields have been a negative for total returns over the past few years. And we see a few reasons why longer-term yields can continue to rise, including higher debt and deficit spending in the US and other developed markets, inflationary policy, and a host of geopolitical risks on the horizon.
At the same time, although we don't know where rates and yields are going to end the year, we do anticipate further volatility this year. And again, that does not favor, in our opinion, taking long duration exposure.
Lastly, areas of the credit market are priced to perfection right now. And that does reflect strong fundamentals and corporate balance sheets, but it does skew risk to the downside because we do think that higher economic uncertainty is not necessarily reflected in current valuation levels. That being said, we do think selective investors can find opportunities right now, and we favor less duration-sensitive credit-oriented investments.
Higher Yields vs. Corporate Bonds and Loans
CLOs are the best way to get this exposure right now, in our opinion.
CLOs are collateralized loan obligations, are securitized pools of leverage loans. They provide higher yields and they've had lower historical default rates than bonds and loans with the same rating because of the way they're structured and their floating rate, meaning they don't have sensitivity to changing interest rates.
The nice thing about CLOs is that they have a full capital structure. So investors can determine the level of risk and return they want to take. So for example, investment grade CLO tranches can help build a robust core bond portfolio while lower rated mezzanine tranches can be an attractive complement or replacement to high yield or leverage loan exposure.
CLOI (VanEck CLO ETF) is an actively managed ETF, sub-advised by Pine Bridge Investments that invest in investment grade CLO tranches, while CLOB (VanEck AA-BB CLO ETF) focuses on lower rated mezzanine tranches, specifically AAs to BBs.
For investors who want to lock in attractive yields right now and take some duration exposure, we think high quality intermediate corporate bonds is an area to take a look. However, spreads are very tight right now, so you do have to be aware of valuations. And we think focusing on attractively valued bonds can provide better outcomes.
MIG (Moody’s Analytics IG Corporate Bond ETF) invests in the most attractively valued bonds in the US investment grade corporate bond market, while MBBB (Moody’s Analytics BBB Corporate Bond ETF) focuses on the triple B segment of that market.
Overall, we're in a changing rate environment and we think investors should be selective this year. And we believe they should lean towards investments that are higher quality and offer attractive value.
IMPORTANT DISCLOSURE
J.P. Morgan Collateralized Loan Obligation Index (CLOIE) tracks broadly-syndicated, arbitrage US CLO debt.
J.P. Morgan CLO AAA Index is a subset of the CLOIE index that only tracks the AAA rated CLO.
J.P. Morgan CLO AA Index is a subset of the CLOIE index that only tracks the AA rated CLO.
J.P. Morgan CLO A Index is a subset of the CLOIE index that only tracks the A rated CLO.
J.P. Morgan CLO BBB Index is a subset of the CLOIE index that only tracks the BB rated CLO.
J.P. Morgan CLO BB Index is a subset of the CLOIE index that only tracks the BB rated CLO.
J.P. Morgan CLO B Index is a subset of the CLOIE index that only tracks the BB rated CLO.
J.P. Morgan Leveraged Loan Index is designed to mirror the investable universe of the USD institutional leveraged loan market.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees. Emerging Market securities are subject to greater risks than U.S. domestic investments. These additional risks may include exchange rate fluctuations and exchange controls; less publicly available information; more volatile or less liquid securities markets; and the possibility of arbitrary action by foreign governments, or political, economic or social instability.
There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative.
An investment in the VanEck CLO ETF (CLOI) may be subject to risks which include, but are not limited to, risks related to Collateralized Loan Obligations (CLO), debt securities, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund investment, management and capital preservation, derivatives, currency management strategies, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, no guarantee of active trading market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, and seed investor risks, all of which may adversely affect the Fund. Investments in debt securities may expose the Fund to other risks, such as risks related to liquidity, interest rate, floating rate obligations, credit, call, extension, high yield securities, income, valuation, privately-issued securities, covenant lite loans, default of the underlying asset and CLO manager risks, all of which may impact the Fund’s performance. Derivatives may involve certain costs and risks such as liquidity, interest rate, and the risk that a position could not be closed when most advantageous.
An investment in the VanEck AA-BB CLO ETF (CLOB) may be subject to risks which include, but are not limited to, risks related to Collateralized Loan Obligations (CLO), debt securities, CLO manager, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund investment, management and capital preservation, derivatives, currency management strategies, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, no guarantee of active trading market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, seed investor, and new fund risks, all of which may adversely affect the Fund. Investments in debt securities may expose the Fund to other risks, such as risks related to liquidity, interest rate, floating rate obligations, credit, call, extension, high yield securities, income, valuation, privately-issued securities, covenant lite loans, and default of the underlying asset risks, all of which may impact the Fund’s performance. Derivatives may involve certain costs and risks such as liquidity, interest rate, and the risk that a position could not be closed when most advantageous.
An investment in the VanEck Moody’s Analytics IG Corporate Bond ETF (MIG) and VanEck Moody’s Analytics BBB Corporate Bond ETF (MBBB) may be subject to risks which include, among others, investing in European issuers, foreign securities, BBB-rated bond, credit, interest rate, restricted securities, financials sector, information technology sector, consumer discretionary sector, consumer staples sector, market, operational, call, sampling, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, data, fund shares trading, premium/discount and liquidity of fund shares, non-diversified, and index-related concentration risks, all of which may adversely affect the fund. The Fund's assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors
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