Make the CLO Call for Added Income

Persistent inflation is highlighting investors’ income needs, but surging interest rates are making life difficult for fixed income investors.

Those scenarios underscore the need for market participants to consider unique income-generating strategies while maintaining favorable risk profiles. Among exchange traded funds that check those boxes, the VanEck CLO ETF (NYSE Arca: CLOI) is an idea to consider.

The actively managed CLOI debuted in June, making it the newest addition to VanEck’s extensive lineup of income-oriented ETFs. That could also make CLOI one of 2022’s most relevant rookie ETFs.

“Collateralized loan obligations (CLOs), which are securitized pools of leveraged loans, may provide several attractive benefits within an income-oriented portfolio, including enhanced yields, structural risk protections, and diversification,” notes William Sokol, VanEck senior product manager. “We believe CLOs are particularly attractive in today’s rising rate environment. They pay floating rate coupons that adjust upwards as rates increase and, unlike fixed coupon bonds, won’t suffer price declines as a result of higher rates.”

The floating rate component of CLOI holdings is clearly relevant today, but it could have staying power. While it’s obvious the Federal Reserve is heading toward more rate hikes this year, the notion that rate increases will halt in 2023 is slowly dwindling. In fact, some market observers believe the Fed’s late efforts to dampen inflation imply the central bank will need to continue boosting borrowing costs in 2024, potentially adding to the allure of CLOI in the process.

Another significant advantage of CLOs, and in turn CLOI, is that the asset class can deliver solid returns without forcing investors to take on added credit risk.

“For example, AA-rated CLOs have provided significantly higher returns than ‘core’ U.S. bonds without significantly higher risk,” adds Sokol. “They’ve also provided similar returns as leveraged loans with lower risk. This is notable because of both the floating rate nature of these asset classes and the stark difference in credit quality (leveraged loans are typically rated BB and below, and an investor in a loan fund has direct exposure to these borrowers).”

Home to 18 holdings, CLOI sports a 30-day SEC yield of 4.26%, which is attractive under any circumstances, but even more so when considering over 85% of the ETF’s holdings carry investment-grade ratings, according to issuer data.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.