CLO Credit Risk Could Be Worth the Gambit

In the world of collateralized loan obligations (CLOs), market participants tend to favor the highest-rated issues, often sticking to CLOs with AAA grades. That’s prudent. It's also an excellent way to dramatically reduce credit risk and volatility. Indeed, the bulk of the CLO market carries high investment-grade ratings.

But there are credit opportunities to be had in the space. The VanEck CLO ETF (CLOI) is an example of an exchange traded fund that can efficiently broaden credit views on the CLO arena.

The actively managed CLOI, which turns two years old in June, allocates nearly 40% of its roster to AAA-rated CLOs. That implies the VanEck ETF offers a best-of-both-worlds approach. It does so providing the stability of the highest-rated CLOs with the income and upside opportunities available with CLOs outside the AAA spectrum.

Call on CLOI for CLO Credit Opportunities

For income investors looking for added performance from CLOs, data confirms CLOI is a credible consideration. That's due to the ratings breadth offered by the ETF.

Single A CLOs outperformed AAA CLOs by 130 bps per year over the past decade, with volatility that was lower than IG corporate bonds,” noted William Sokol, VanEck director of product management. “BBB CLOs provide a yield pickup over AAA CLOs of +219 bps, and provide a yield pickup over high yield bonds, with higher credit quality.”

He added AA-rated CLOs also have a penchant for beating broader investment-grade corporate bond strategies as well aggregate bond funds. The $274 million CLOI allocates about 45% of its lineup to CLOs rated AA, A and BBB.

From an income perspective, that diversification is meaningful, because BBB CLOs sport higher yields than broader measures of traditional junk bonds, while the yields on CLOs rated A and AA far exceed, on average, what investors earn with diverse investment-grade corporate bond funds. With a 30-day SEC yield of 6.83%, CLOI reflects the compelling proposition offered by this asset class.

“Further, CLO yields assume a certain loss rate in the calculation, so default assumptions are already reflected. This may provide additional comfort to those who are wary of investing outside of AAA tranches. Corporate bond yields do not make similar adjustments for potential defaults,” observed Sokol.

Additionally, CLOs are an asset class where active management can thrive, further highlighting the potential utility of CLOI. As noted by Sokol, an active approach to CLOs can provide some protection as the possibility of the upside of rewards.

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

Read more on ETFTrends.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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