Collateralized loan obligations (CLOs), single securities supported by larger pools of debt, are one of the corners of the fixed income that aren’t as vulnerable to rising interest. This is expecially compared to, say, long-dated Treasurys and corporate bonds.
Alone, the ability to grab rising rates protection makes the VanEck CLO ETF (NYSE Arca: CLOI) – the original exchange traded fund dedicated to CLOs -- appealing to income investors. Fortunately, CLOI’s perks don’t end with its protection against Federal Reserve tightening.
CLOI, which turned a year old in June, sports a 30-day SEC yield of 6.49%, confirming that there is indeed an attractive income proposition with CLOs. That yield is all the more noteworthy. CLO investors aren't compensated for rate risk.
Exploring CLOI Benefits
It’s an in the weeds topic for most investors. Still, high carry is one reason why CLOs and CLOI are proving sturdy relative to other fixed income asset. Higher short-term interest rates and elevated spreads support high carry.
“The latter point is notable, because other areas of the credit market continue to provide compensation for credit risk that is at or below historical averages, despite widespread expectations of some degree of an economic slowdown,” noted William Sokol, VanEck director of product management.
Returning to CLOI’s lack of rate risk, that’s notable at this time. Some observers are speculating that the Fed may raise rates again before the end of the year while putting off rate cuts until well into 2024. That could imply potential downside for Treasurys and rate-sensitive corporate debt. In other words, CLOs are attractive on a risk/reward basis.
“Because they provide higher spreads than similarly rated corporates and provide built-in risk protections, they have historically provided higher levels of income for a lower level of risk. As a result, we believe investors should consider a strategic position in CLOs within a core bond portfolio – not just in times of rising interest rates,” added Sokol.
Of course, with CLOI’s lofty yield, smart investors are apt to ask about credit risk. This is particularly relevant because the ETF isn’t vulnerable to Fed tightening. The VanEck ETF answers that call with aplomb. Nearly 95% of its holdings are rated with one of the three “A” grades. Additionally, VanEck actively manages CLOI. It can nimbly navigate erosion in holdings’ credit quality, should that scenario come to pass.
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