CLOI defensive positioning drives outperformance in Q3
|Investment Grade Companies||-5.11||-18.33||5.74||167|
|Agglo United States||-4.86||-14.68||4.71||59|
|High yield bonds||-0.68||-14.62||9.57||543|
Source: JP Morgan, ICE Data Indices as of 09/30/2022. CLOs represented by the JP Morgan CLO Index; AAA-rated CLOs represented by the JP Morgan CLO AAA Index, AA-rated CLOs represented by the JP Morgan CLO AA Index, A-rated CLOs represented by the JP Morgan CLO A Index, BBB-rated CLOs represented by the JP Morgan CLO BBB Index , BB-rated CLOs represented by JP Morgan CLO BB Index, Investment Grade Corporates represented by ICE BofA US Corporate Index, US Agg is represented by ICE BofA US Broad Market, Leveraged Loans represented by JP Morgan Leveraged Loan Index and High Yield Bonds represented by the ICE BofA US High Yield Index. The leveraged loan yield represents the modeled yield at a 3-year maturity. US CLO Yield to Worst represents the yield when buying securities at premium or until maturity when priced at a discount to par based on forward benchmark rates.
According to Barclays Research, the supply of new CLO issues increased month-on-month after the summer lull, with a price of $13.3 billion in the month, up from $7.6 billion. in August. Primary issuance is down 19% from 2021 levels. For the third month in a row, no refis or resets were priced in September, after a price of just $0.3 billion in May and June. Total issuance for the year is now 60% lower than in 2021. In the secondary market, TRACE’s supply fell to $16.1 billion in September from $11.4 billion in August, according to Morgan Stanley. Investment-grade volumes increased to $11.8 billion from $8.4 billion in August and lower-grade volumes increased to $4.3 billion from $3.0 billion. Total BWIC volumes increased to $5.2 billion from $3.8 billion in August.
There were two defaults in the Morningstar/LSTA Leveraged Loan Index in September. As a result, the 12-month default rate, by principal, fell from 0.60% in August to 0.90%. We expect the default rate to remain below historical averages in 2022 for the leveraged loan market, despite continued interest rate hikes and indications that Federal Reserve (Fed) hikes will continue throughout. throughout the calendar year. We expect the default rate to increase over the medium term, although we still expect defaults to remain below the long-term historical average of around 3%.
CLO fundamentals were mixed month over month, with credit metrics remaining relatively flat, while market value metrics were significantly weaker. According to Barclays Research and Morgan Stanley, the junior overcollateralization buffer decreased by 1bp to 495bp, CCC/Caa tranches fell from 3.6%/3.2% in August to 3.6%/3.3% in September, the weighted average rating factor (which measures overall credit quality by rating) remained constant, the weighted average spread increased by 2 basis points to 350 basis points, and the exposure to loans whose price is below $90 and below $80 increased by 10.4% to 20.4% and 1.5% to 5.6%, respectively.
Portfolio Strategy: Evolving the Capital Stack
While CLO metrics remain broadly strong, CLO spreads have widened to levels last seen during the peak of the COVID-19 crisis in 2020, as continued geopolitical and economic risks continue to weigh on sentiment. of the market. Despite their relative strength against other fixed income assets at the start of the year, the significant widening of spreads created additional relative value opportunities for CLOs in the secondary market. Additionally, we believe that CLOs will benefit from inflows into the asset class due to the asset class’ very good historical performance under rising default scenarios as well as the floating nature of CLOs. Although the spreads are at the widest levels of the year, they could widen a bit more from here before stabilizing. Accordingly, we continue to move portfolios up the capital stack while adding value through careful stock selection.
The Fund returned 0.02% for the quarter ended September 30, 2022, outperforming its benchmark, the JP Morgan CLO Index, by 0.13%. The outperformance was mainly due to stock selection within the BBB-rated tranche. A higher allocation to A and AA rated tranches also contributed positively, as well as an underweight to BB rated CLOs, reflecting a current conservative positioning. The main detractors from relative performance were the selection within the A-rated tranche and the underweight to the AAA-rated tranches.
Future Outlook: Uncertainty Drives Defensive Positioning
The outlook for the broader US economy remains unclear. The Fed continues to emphasize the tight labor market as the main underlying catalyst for inflation, so a central bank pivot remains unlikely in the near term. Job vacancies still outnumber jobless claims, in contrast to falling inflation in other areas of the economy as measured in business surveys and evidenced by the slowdown in the housing market, heightening fears of a policy error by the Fed. The higher likelihood of a recession has contributed to volatility in financial markets which are already struggling with higher rates and a shortage of liquidity in the current economic environment. Current conditions will likely persist and thwart forecasts until further clarity emerges around where rates will peak.
In this environment, high yield floating rate asset classes like CLOs can offer an attractive return opportunity among credit assets while remaining relatively insulated from geopolitical risks. Additionally, we believe demand for CLOs will continue to be robust as negative real rates will continue to prompt investors to take advantage of the recovery in yields and the relative attractiveness of CLOs versus other credit assets.
However, given the level of uncertainty in the market, we do not believe this is the time to adopt a global risk-based positioning. Instead, we believe further rallies will provide a good opportunity to further de-risk and benefit our prior stance of maintaining a slightly defensive positioning, looking to add relative value at the level of stock selection and managers.
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Originally published by VanEck on October 26, 2022.
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JP Morgan Collateralized Loan Obligation Index (CLOIE) is made up of widely syndicated arbitrage CLOs denominated in US dollars.
AAA-rated CLOs represented by the JP Morgan CLO AAA Index is a subset of the CLOIE index that tracks only the AAA-rated CLO.
AA-rated CLOs represented by the JP Morgan CLO AA Index is a subset of the CLOIE index that tracks only the AA-rated CLO.
A-rated CLOs represented by the JP Morgan CLO A Index is a subset of the CLOIE index that only tracks the A-rated CLO.
BBB-rated CLOs represented by the JP Morgan CLO BBB Index is a subset of the CLOIE index that tracks only the BB-rated CLO.
BB-rated CLOs represented by the JP Morgan CLO BB Index is a subset of the CLOIE index that tracks only the BB-rated CLO.
ICE BofA US Corporate Index (C0A0) tracks the performance of US dollar-denominated investment-grade corporate debt publicly issued in the US domestic market.
ICE BofA US High Yield Index (H0A0) tracks the performance of below-investment grade US dollar-denominated corporate debt publicly issued in the US domestic market.
ICE BofA US Large Market (US00) tracks the performance of publicly issued US dollar-denominated investment-grade debt securities in the US domestic market, including US treasury bills, quasi-government securities, corporate securities, securitized securities, and collateralized securities.
JP Morgan Leveraged Loan Index includes US dollar leveraged loans.
Morningstar/LSTA Leveraged Loan Index includes US dollar leveraged loans.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not imply the provision of personalized investment, financial, legal or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, speak as of the date of this communication and are subject to change without notice. Information provided by third party sources is believed to be reliable and has not been independently verified as to its accuracy or completeness and cannot be guaranteed. The information contained herein represents the opinion of the author(s), but not necessarily that of VanEck.
An investment in the VanEck CLO ETF (CLOI) may be subject to risks which include, but are not limited to, Collateralized Loan Obligations (CLOs), Debt Securities, LIBOR Replacement, Foreign Currency, Foreign Securities, orientation of investments, newly issued securities, extended settlement, affiliated fund, management, derivatives, cash transactions, market, sub-advisor, operational, concentration of authorized participants, new fund, absence of a prior active market, problems of trading, fund share trading, premium/discount, fund share liquidity, non-diversified risk and seed investors. The Fund may also be subject to liquidity, interest rate, floating rate note, credit, call, extension, high yield securities, income, valuation, securities issued by the private sector, covenant lite loans, default of the underlying asset and CLO manager risk, all of which could adversely affect the Fund.
Investing involves substantial risks and high volatility, including possible loss of capital. An investor should carefully consider the investment objective, risks, charges and expenses of the Sub-Funds before investing. To obtain a prospectus and a summary of the prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and simplified prospectus carefully before investing.
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