The Federal Reserve obliged fixed income investors by lowering interest rates in September. However, spreads for investment-grade and high-yield debt are tight. This indicates those bond segments may not be adequately compensating market participants for added risk. Collateralized loan obligations (CLOs) could be just what the doctor ordered for the current bond climate.
That asset class can be efficiently accessed thanks to exchange traded funds such as the VanEck CLO ETF (CLOI ) – one of the largest and oldest funds in the category – and the newly minted VanEck AA-BB CLO ETF (CLOB).
CLOI and CLOB are worth of consideration by income investors with long-term time horizons, but the VanEck ETFs could merit closer near-term examination because as William Sokol, VanEck director of product management, noted during VettaFi’s Fixed Income Symposium, treasury yields are higher today than they were at the start of 2024. CLOs are less rate-sensitive than some other bonds and could be ideal for investors looking to mitigate fixed income volatility.
“Rates are higher than they were at the beginning of the year, and I actually think that’s taken a lot of investors by surprise,” noted Sokol. “Now maybe that makes rates more attractive for sure. But we think volatility is really going to be a factor going forward, certainly for the next few weeks. I mean, we have an election coming up and we actually see a strong case for continued high and maybe even higher long-term yields, so we think it makes sense to be cautious right now.”
Exploring CLO Benefits
CLOs are unique in that they’re higher up on the chain of claims than other senior debt. Additionally, the VanEck ETFs highlight that investors can access the perk across a variety of credit grades.
“You have the pool of loans and then the CLO issues several classes of debt to purchase those loans. Typically, you’re going to see tranches rated from AAA to BB,” added Sokol. “The more senior tranches get paid first and they’re the last to absorb losses and then vice versa. That structure really allows investors to tailor the level of risk they want to take, and of course, the expected return that they’ll generate in their portfolio.”
Regarding credit risk, investors should be careful to not conflate CLOs with collateralized debt obligations (CDOs). CDOs gained infamy during the global financial crisis. Plus, VanEck actively manages CLOI and CLOB. This indicates that the asset class tempers credit risk while not pinching income.
“CLOs are actually actively managed, so every pool of loans in the CLO has an active credit manager selecting loans, changing the portfolio, avoiding names they don’t like. That’s really important for the ongoing credit worthiness of the portfolio,” observed Sokol.
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