CLOI - CLOI ETF: Take Advantage Of Resilient Short-Term Rates

2023-09-29 11:05:36 ET

Summary

• The VanEck CLO ETF focuses on investing in high-quality collateralized loan obligations and has performed well in the past year.
• The CLOI ETF might benefit from the "higher for longer" interest rate environment.
• Credit spreads might settle lower as the longer end of the U.S. yield curve is starting to tick up.
• The VanEck CLO ETF provides solid shareholder compensation. However, keep in mind that the ETF does possess cyclical attributes.

Today's analysis looks at the VanEck CLO ETF ( CLOI ) , which functions as a leveraged loan investment vehicle. In our view, the VanEck CLO ETF might be incredibly rewarding in today's interest rate environment; moreover, we think the general credit arena is aligning in a way that could benefit VanEck CLO ETF in the interim.

Without further ado, let's introduce the VanEck CLO ETF and discuss why the ETF could outperform expectations in the coming quarters.

An Overview of CLOI ETF

The VanEck CLO ETF's model focuses on investing in high-quality collateralized loan obligations, meaning it essentially invests in the debt that high-quality companies issue to secure their own leveraged acquisitions.

The VanEck CLO ETF has performed quite well in the past year as high short-term interest rates and movement in the credit curve (discussed later in the article) led to a promising environment.

As displayed within the next diagram, the VanEck CLO ETF invests in high-quality debt, with approximately 82.97% of its portfolio exposed to AAAs. The fund typically invests more than 80% of its capital in investment-grade debt, meaning its style-based characteristics will likely stay the same throughout its tenure.

Although the VanEck CLO ETF has a credit quality constraint, its duration is unconstrained. As such, investors can anticipate active duration management from this ETF.

The way things are, the VanEck CLO ETF is speculating on the belly of the curve, with its primary exposure being intermediate 7 to 10s.

Key Value Drivers

Levered loan vehicles such as the VanEck CLO ETF heavily rely on short-term rates and spreads as their constituents usually pay a market reference rate + a spread.

As a rule of thumb, you want to see short-term rates higher, and credit spreads lower with collateralized loan obligations, or CLOs, as that allows solid interest payments while the adverse price effects from higher short-term rates get phased out by receding credit spreads.

The overnight funding rates remain high within the U.S., and we think the "higher for longer" interest rate rhetoric might assist this CLO. In fact, inflation isn't backing down as most believed it would, suggesting CLOs might benefit from a sustained period of high benchmark and reference rates alike.

Furthermore, although credit spreads remain high, there's been tapering in recent months. Moreover, the longer end of the yield curve is starting to steepen , suggesting that credit spreads might continue to diminish (the slope of the curve and credit spreads are countercyclical).

Lastly, it is illustrated below that the VanEck CLO ETF's premium over NAV is around 0.19%. We are fairly neutral on its current premium as it has showcased significantly higher and lower premiums in the past (relative to its current level). In addition, it seems like the market is trying to find direction on statistical arbitrage opportunities, which is conveyed by the recent oscillation of the VIX ( VIX ).

Potential Shareholder Compensation

The VanEck CLO ETF provides investors with solid compensation. Consider that this is a recently-listed ETF, meaning its dividend growth roadmap is still in its early stages. However, also keep in mind that its dividend yield will likely shrink as interest rates decline. Nevertheless, we see a solid income-generating investment opportunity in VanEck CLO ETF.

Risks

Let's run through a few risks related to the VanEck CLO ETF.

I mentioned earlier in the article that bond market features suggest credit risk is dissipating. However, a vantage point of the real economy contradicts the notion. For example, the jobs market within the U.S. is struggling for direction, consumer sentiment is curtailing once more, and PMI numbers remain below 50 . Therefore, qualitative variables might end up dominating the day, concurrently sending credit spreads upward and devaluing the VanEck CLO ETF.

Another factor to consider is the VanEck CLO ETF's value-at-risk. According to YCharts' data, the VanEck CLO ETF will likely shed at least 1.35% of its value in 5% of its traded months. Even though 1.35% might not seem like a lot, keep in mind that this is a risk-off investment; thus, the figure should be taken into context.

Final Word

The higher for longer interest rate environment paired with receding credit spreads presents solid opportunities in the collateralized loan obligation space. The VanEck CLO ETF provides exposure to high-quality investment-grade loans with outstanding returns on capital due to the elevated interest rate environment; moreover, price impact from higher rates will likely be phased out by receding credit spreads.

The VanEck CLO ETF provides solid dividends, has the potential for additional price gains, and hosts a low-risk portfolio. Therefore, we are bullish on CLOI ETF.

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