CLOI - CLOI: Exposure To CLO Asset Class
2023-03-10 01:58:31 ET
Summary
- VanEck CLO ETF gives retail investors exposure to investment-grade CLO tranches.
- CLOs have historically performed better than similarly rated bonds and loans.
- While the historical returns of the asset class are attractive, I am not 100% comfortable with the lack of portfolio disclosures on CLOI.
The VanEck CLO ETF ( CLOI ) gives retail investors exposure to the CLO asset class, which has traditionally only been available to institutional investors or through high cost closed-end funds. While it is still early days, results for the CLOI ETF have been promising, with a 5.9% return since inception in June 2022. Historically, investment-grade CLOs have generated attractive returns. However, for now, I am staying on the sidelines on CLOI, as I am not 100% comfortable with the lack of portfolio disclosures on credit quality allocation and indirect fees.
Fund Overview
The VanEck CLO ETF is an actively managed ETF that provides exposure to the Collateralized Loan Obligation ("CLO") asset class for retail investors. CLOI is sub-advised by PineBridge Investments and primarily invests in investment grade-rated tranches of CLOs.
What are CLOs
A CLO is a collection of senior loans that have been packaged, securitized, and tranched (Figure 1). The securitization and tranching allows AAA-rated securities to be created from underlying loans that may not be rated AAA themselves. This financial engineering gives risk-averse investors a broader universe of highly rated securities to invest in.
There are two key attributes to know about CLOs. First, cash flows down through a CLO structure, i.e., any cash flows collected from the underlying portfolio of leveraged loans are first used to pay obligations to the AAA-rated tranche, then the AA-rated tranche, and so on and so forth. Second, losses flow up through a CLO structure, i.e. any credit losses are first experienced by the unrated Equity tranche, then the B-rated tranche, and so on and so forth. CLOs are also usually overcollateralized, i.e. $110 million in leveraged loans are pooled to create $100 million face value of rated securities.
Historically, CLOs have performed well. Out of over 4,000 CLOs that were issued before the Great Financial Crisis ("CLO 1.0"), less than 1% of the rated-tranches have defaulted (Figure 2).
Figure 2 - CLOs have performed well (guggenheiminvestments.com)
Since 2008, additional credit enhancements have been added to typical CLO structure ("CLO 2.0"), including additional overcollateralization and limits to investments in other asset classes. This has resulted in even lower default rates for CLO 2.0s as of June 30, 2022.
Compared to similarly rated bonds and leveraged loans, CLOs have historically generated higher returns and trade at wider credit spreads (Figure 3).
Figure 3 - CLOs have delivered superior returns (pinebridge.com)
Investors who want to learn more about the CLO asset class are encouraged to do so online through Pinebridge's website or one of the other managers that offer CLO investment vehicles.
Portfolio Holdings
As of February 28, 2023, the CLOI ETF has 56% of the portfolio invested in investment grade rated securities and 8% in unrated securities (Figure 4).
Investors should note that the percentage held in investment grade securities is less than the weighting in the prospectus (Figure 5). It is unclear whether the discrepancy is because the fund is still ramping up, or from some other reason. Unfortunately, VanEck does not provide additional details on the portfolio.
Figure 5 - CLOI prospectus says the fund invests 80% in investment grade CLO tranches (CLOI prospectus)
Figure 6 shows a full listing of the CLOI ETF's portfolio. Notice the lack of additional information regarding the individual CLO tranches.
Returns
The CLOI ETF is a newly launched fund, with an inception date of June 21, 2022, so there are not much historical returns to measure the fund by. Since inception, the ETF has returned 5.9% to February 28, 2023, a respectable performance compared to other fixed income investments which suffered tremendously in 2022 (Figure 7).
Figure 7 - CLOI has limited returns history (morningstar.com)
Distribution & Yield
The CLOI ETF pays a monthly distribution, with $1.59 paid in the 8 months since distributions started (Figure 8). If we annualize this amount, the CLOI ETF would yield 4.6% on a trailing basis. The CLOI ETF also has a 30-Day SEC yield of 5.9%.
Fees
The CLOI ETF charges a relatively low 0.40% net expense ratio (Figure 9). However, the figure is a little misleading, as the CLO investments themselves have management fees.
For example, more established CLO funds like Oxford Lane Capital ( OXLC ) charges a 10.52% total expense, which includes management fees, incentive fees and leverage fees (Figure 10).
Figure 10 - OXLC is a very expensive CEF (OXLC 2022 annual report)
However, buried in OXLC's notes, we learn that if indirect expenses of the CLO investments are included, annual fees are an eye-watering 30.69% (Figure 11).
Figure 11 - Including indirect expenses will almost triple OXLC's fees (OXLC 2022 annual report)
I expect a similar level of indirect expenses will be charged to the CLOI ETF, since the underlying assets between OXLC and CLOI are similar.
Conclusion
The CLOI ETF gives retail investors exposure to the CLO asset class, which has traditionally only been available to institutional investors or through high cost closed-end funds ("CEF"). While it is still early days, results for the CLOI ETF have been promising, with a 5.9% total return since inception in June 2022. Historically, investment-grade CLOs have provided attractive returns. However, I am staying on the sidelines for now on CLOI, as I am not 100% comfortable with the lack of portfolio disclosures regarding credit quality allocation and indirect fees.
For further details see:
CLOI: Exposure To CLO Asset Class