Why Invest in CLOs?
February 13, 2023
Read Time 4 MIN
Over the long term, collateralized loan obligation (CLO) tranches have historically performed well relative to other corporate debt categories, including leveraged loans, high yield bonds, and investment grade bonds, and have significantly outperformed at lower rating tiers. CLOs are structured to help mitigate risk, through the strength of their underlying collateral as well as built-in traits such as coverage tests to correct collateral deterioration. This has historically helped them experience significantly lower levels of principal loss when compared with corporate debt and other securitized products. This has resulted in a track record of strong risk-adjusted returns versus other fixed income asset classes.
CLOs Track Record of Strong Risk-Adjusted Returns vs. Other Asset Classes
10 Years as of 8/31/2024
Source: Morningstar. Broad CLOs represented by J.P. Morgan CLO Index, IG CLOs represented by J.P Morgan CLO IG Index, AA-BB CLOs represented by the J.P. Morgan CLOIE Balanced Mezzanine Index, AAA Rated CLOs represented by J.P. Morgan CLO AAA Index, AA Rated CLOs represented by J.P. Morgan CLO AA Index, A Rated CLOs represented by J.P. Morgan CLO A Index, BBB Rated CLOs represented by J.P. Morgan CLO BBB Index, BB Rated CLOs represented by J.P. Morgan CLO BB Index, US IG represented by ICE BofA US Corporate Index, US HY represented by ICE BofA US High Yield Index, Agg is represented by the ICE BofA US Broad Market, US IG FRNs represented by MVIS US Investment Grade Floating Rate Note Index, Leveraged Loans represented by Morningstar LSTA US Leveraged Loan 100 Index. See index descriptions at the end of this blog. Past performance is not indicative of future results. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
CLOs Have Been Tested Through Two Major Crises
Through both the Global Financial Crisis and COVID-19 drawdown, the asset class ultimately experienced far fewer defaults than corporate bonds of the same rating. For example, among the nearly 20,000 U.S. CLOs issued from 1996-2021 and rated by S&P, only 60 experienced defaults, primarily in non-investment grade rated tranches. And the performance is even better for investment grade CLOs. In the higher rated AAA and AA CLO tranches, there have been zero defaults. We believe this resilience combined with the potential for upside returns makes the asset class compelling for long-term minded investors.
CLOI | VanEck CLO ETF
The Search for Income is Over
In addition to this strong track record of risk-adjusted returns, CLO spreads have historically been significantly wider than those of other debt instruments.
Consistent Spread Pickup by CLOs Compared to Similarly Rated Bonds
(In bps as of 8/31/2024)
Source: JP Morgan and ICE Data Services. Using option-adjusted spread for corporate bonds and discount margins for CLOs. AAA Rated CLOs represented by J.P. Morgan CLO AAA Index, AA Rated CLOs represented by J.P. Morgan CLO AA Index, A Rated CLOs represented by J.P. Morgan CLO A Index, BBB Rated CLOs represented by J.P. Morgan CLO BBB Index, BB Rated CLOs represented by J.P. Morgan CLO BB Index, B Rated CLOs represented by J.P. Morgan CLO B Index AAA Rated Corps represented by the ICE BofA AAA US Corporate Index, AA Rated Corps represented by the ICE BofA AA US Corporate Index, A Rated Corps represented by the ICE BofA A US Corporate Index, BBB Rated Corps represented by the ICE BofA BBB US Corporate Index, BB Rated Corps represented by the ICE BofA BB US High Yield Index and B Rated Corps represented by the ICE BofA Single-B US High Yield Index. Index descriptions at the end of this blog. Past performance is not indicative of future results. Index performance is not illustrative of fund performance. It is not possible to invest directly in an index.
CLOs Have Lower Sensitivity to Interest Rates
CLOs are also floating-rate instruments, meaning they have low sensitivity to changes in interest rates. As interest rates rise or fall, CLO yields will move accordingly, and their prices have historically moved less than those of fixed-rate instruments. These characteristics may be advantageous to investors in diversified fixed income portfolios.
With higher relative yields, a history of strong risk-adjusted returns, and protection against rising rates, we believe there are several benefits to making a strategic allocation to investment grade CLOs within an income portfolio.
CLOB | VanEck AA-BB CLO ETF
How to Invest in CLOs
The CLO market is largely institutional, with banks, insurance companies and hedge funds often purchasing CLOs directly or through institutional separate accounts that may carry minimums of $50M or more. This may make access difficult for many investors.
The VanEck CLO ETF (CLOI) and VanEck AA-BB CLO ETF (CLOB) may offer attractive ways for investors to efficiently access this market with the liquidity, transparency and low cost features of an ETF. CLOI and CLOB are actively managed ETFs, sub-advised by PineBridge Investments. CLOI provides access to investment grade CLOs, and CLOB invests primarily in mezzanine tranches of CLOs. Both ETFs benefit from PineBridge’s decades of CLO market experience, both as a CLO manager and CLO tranche investor, and deep leveraged finance expertise.
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DISCLOSURES
J.P. Morgan Collateralized Loan Obligation Index (CLOIE) tracks US dollar denominated broadly syndicated, arbitrage CLOs.
J.P. Morgan CLO IG Index is a subset of the CLOIE index that tracks AAA – BBB rated CLO.
J.P. Morgan CLOIE Balanced Mezzanine Index tracks broadly-syndicated, arbitrage US CLO debt rated AA to BB, comprised of 25% of each rating category.
ICE BofA US Corporate Index (C0A0) tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.
ICE BofA US High Yield Index (H0A0) tracks the performance of U.S. dollar-denominated below investment grade corporate debt publically issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating. Original issue zero coupon bonds, 144a securities, both with and without registration rights, and pay-in-kind securities, including toggle notes, qualify for inclusion. Eurodollar bonds, taxable and tax-exempt U.S. municipal, warrant-bearing, DRD-eligible and defaulted securities are excluded from the Index.
ICE BofA US Broad Market (US00) tracks the performance of US dollar denominated investment grade debt publicly issued in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
Morningstar LSTA US Leveraged Loan 100 Index seeks to mirror the market-weighted performance of the largest institutional leveraged loans as determined by criteria based upon market weightings, spreads, and interest payments.
MVIS US Investment Grade Floating Rate Index (MVFLTR) consists of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one rating agency.
J.P. Morgan Leveraged Loan Index tracks broadly syndicated leveraged loans.
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 BBB 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 B rated CLO.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. 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. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
An investment in the VanEck CLO ETF (CLOI) may be subject to risks which include, among others, Collateralized Loan Obligations (CLO), debt securities, LIBOR Replacement, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund, management, derivatives, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, new fund, absence of prior active market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, and seed investor risks. The Fund may also be subject 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 adversely affect the Fund.
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.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Funds carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly-owned subsidiary of Van Eck Associates Corporation.
Related Funds
DISCLOSURES
J.P. Morgan Collateralized Loan Obligation Index (CLOIE) tracks US dollar denominated broadly syndicated, arbitrage CLOs.
J.P. Morgan CLO IG Index is a subset of the CLOIE index that tracks AAA – BBB rated CLO.
J.P. Morgan CLOIE Balanced Mezzanine Index tracks broadly-syndicated, arbitrage US CLO debt rated AA to BB, comprised of 25% of each rating category.
ICE BofA US Corporate Index (C0A0) tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.
ICE BofA US High Yield Index (H0A0) tracks the performance of U.S. dollar-denominated below investment grade corporate debt publically issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating. Original issue zero coupon bonds, 144a securities, both with and without registration rights, and pay-in-kind securities, including toggle notes, qualify for inclusion. Eurodollar bonds, taxable and tax-exempt U.S. municipal, warrant-bearing, DRD-eligible and defaulted securities are excluded from the Index.
ICE BofA US Broad Market (US00) tracks the performance of US dollar denominated investment grade debt publicly issued in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
Morningstar LSTA US Leveraged Loan 100 Index seeks to mirror the market-weighted performance of the largest institutional leveraged loans as determined by criteria based upon market weightings, spreads, and interest payments.
MVIS US Investment Grade Floating Rate Index (MVFLTR) consists of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one rating agency.
J.P. Morgan Leveraged Loan Index tracks broadly syndicated leveraged loans.
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 BBB 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 B rated CLO.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. 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. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
An investment in the VanEck CLO ETF (CLOI) may be subject to risks which include, among others, Collateralized Loan Obligations (CLO), debt securities, LIBOR Replacement, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund, management, derivatives, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, new fund, absence of prior active market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, and seed investor risks. The Fund may also be subject 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 adversely affect the Fund.
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.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Funds carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly-owned subsidiary of Van Eck Associates Corporation.