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Collateralized Loan Obligations (CLOs) remain one of the most misunderstood investment vehicles in the financial world. VanEck’s Fixed Income ETF Portfolio Management team, represented by Fran Rodilosso and Bill Sokol, shed light on the benefits and misconceptions surrounding CLOs in a recent discussion. As active management and structured credit gain traction, financial advisors are increasingly looking at CLOs as a way to diversify portfolios and enhance yield.
CLOs are securitized pools of leveraged loans, commonly known as bank loans or syndicated loans, which are issued to cash-flow-generating companies. These loans are structured in tranches, from the highest-rated AAA to the more junior equity tranches, offering investors a range of risk and return profiles. Historically, CLOs have demonstrated resilience, boasting lower default rates compared to similarly rated corporate bonds. Their floating-rate nature makes them particularly attractive in environments of rising interest rates, as they provide higher yields without significant interest rate risk.
One of the key benefits of CLOs is their ability to provide both diversification and enhanced returns. Because of their structured nature, they allow investors to select the level of risk they wish to take. The higher-rated tranches offer a relatively stable income stream with minimal credit risk, while the lower-rated mezzanine tranches provide opportunities for higher returns in exchange for increased exposure to credit market fluctuations.
Why Active Management Matters in CLO Investing
Active management plays a crucial role in optimizing CLO investments. The complexity of CLO structures, combined with the varying creditworthiness of the underlying loans, requires in-depth analysis and ongoing portfolio adjustments. VanEck’s CLO ETFs, CLOI and CLOB, leverage the expertise of PineBridge Investments, a firm with decades of experience in structured credit markets.
CLOI focuses on investment-grade CLO tranches, primarily AAA, AA, and A-rated securities, to provide income with lower volatility. CLOB, on the other hand, targets mezzanine tranches, including BBB and BB-rated CLOs, offering higher yields for investors willing to accept more credit risk. Both ETFs employ rigorous manager selection, re-underwriting of portfolios, and ongoing risk assessment to ensure optimal asset allocation and mitigate downside risks.
For financial advisors, CLOs can be a valuable addition to both core fixed-income portfolios and high-yield allocations. The floating-rate nature of CLOs helps hedge against interest rate risk, while their structured design offers a level of credit enhancement not found in traditional corporate bonds. Moreover, CLO ETFs provide liquidity and cost efficiency, making them an accessible way to gain exposure to this historically institutional-dominated asset class.
As the financial landscape continues to evolve, CLOs present a compelling opportunity for advisors seeking to enhance portfolio resilience and generate superior risk-adjusted returns. With active management and a strategic approach, CLOs can serve as a powerful tool in building diversified and high-performing investment portfolios.
Related: Unlocking CLO Opportunities with Fran Rodilosso and Bill Sokol