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CLOs and loans significantly outperformed other credit asset classes in 2022, and the asset class enters the new year at materially higher yields and spreads versus one year ago. The VanEck CLO ETF (the “Fund”) (CLOI) outperformed the J.P. Morgan CLO Index in the fourth quarter by 0.13%, and since launching in June 2022 has outperformed by 0.57%, driven by both portfolio positioning and security selection. With credit conditions expected to deteriorate this year, the portfolio remains conservatively positioned.
Market Update: CLOs Rally Amid Lower Than Expected Inflation
CLOs continued their fourth quarter rally in December, as easing inflation concerns improved investor sentiment despite the continued hawkish narrative from the Federal Reserve. Inflation was lower than anticipated in November with the narrative shifting during the second half of the month amid hawkish surprises from central banks and weak global economic data, although CLOs held on better than most other risk assets. The Federal Reserve raised interest rates by 50bps during the month, the seventh rate increase in 2022, albeit at a slower pace than the prior four meetings.
| Asset class | Q4 2022 Return (%) | 2022 Return (%) | Yield to Worst (%) | Spreads (bps) |
| CLOs | 3.03 | 0.21 | 6.92 | 273 |
| AAA | 2.54 | 1.05 | 6.18 | 193 |
| AA | 3.23 | -0.17 | 6.65 | 264 |
| A | 4.10 | -1.67 | 7.50 | 353 |
| BBB | 4.77 | -2.77 | 9.31 | 532 |
| BB | 6.43 | -3.82 | 14.69 | 1022 |
| Investment Grade Corporates | 3.53 | -15.44 | 5.51 | 138 |
| U.S. Agg | 1.78 | -13.16 | 4.70 | 54 |
| Leveraged Loans | 2.79 | 0.06 | 10.83 | 597 |
| High Yield Bonds | 3.98 | -11.22 | 8.98 | 481 |
Source: JP Morgan and ICE Data Indices as of 12/31/2022. CLOs represented by J.P. Morgan Collateralized Loan Obligation Index, AAA Rated CLOs represented by J.P. Morgan CLO AAA Index, AA Rated CLOs represented by J.P. Morgan CLO AA Index, A Rated CLOs represented by J.P. Morgan CLO A Index, BBB Rated CLOs represented by J.P. Morgan CLO BBB Index, BB Rated CLOs represented by J.P. Morgan CLO BB Index, Investment Grade Corporates represented by ICE BofA US Corporate Index, US Agg is represented by the ICE BofA US Broad Market, Leveraged Loans represented by JP Morgan Leveraged Loan Index and High Yield Bonds represented by ICE BofA US High Yield Index. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities mentioned herein.
Per Barclays Research, CLO new issue supply decreased month-over-month, with $4.7B pricing during the month compared to $8.6B in November. While primary issuance ended the year down 31% from 2021 levels, it was the second-highest level on record. Refis and resets ended a five-month streak of none pricing, with $0.4B pricing in December. Total issuance for the year was 65% lower compared to 2021. In the secondary market, TRACE supply decreased to $11.9B in December from $20.9B in November, per Morgan Stanley. Total TRACE volume during 2022 of $200B with investment grade volumes of $153B were records for the CLO 2.0 market.
There were no new defaults in the Morningstar LSTA Leveraged Loan Index in November. As a result, the trailing 12-month default rate, by principal, decreased marginally to 0.72% from 0.73% in November. We anticipate the default rate to remain below historical averages in the near term for the leveraged loan market, notwithstanding ongoing interest rate increases and indications that Fed hikes will maintain higher interest rates throughout 2023. We anticipate the default rate to increase over the medium term, though our expectations remain that defaults will stay below the long-term historical average of ~3%.
Portfolio Strategy: Security Selection and Ratings Exposure Drive Performance
The Fund returned 3.16% in the quarter ended December 31, 2022, outperforming its benchmark, the J.P. Morgan CLO Index, by 0.13%. The Fund’s ability to shift within investment grade buckets has been a positive driver of outperformance since launching in June 2022. For example, an overweight to BBB rated CLOs provided some outperformance in the less volatile summer months, before shifting to a more conservative allocation as volatility picked up later in the summer. In addition, security selection within rating categories has been a driver of outperformance vs its benchmark, particularly among AA and BBB rated CLOs.
CLOI Total Return and Credit Allocation
Source: FactSet, JP Morgan and VanEck. CLOIE represented by J.P. Morgan Collateralized Loan Obligation Index and AAA Rated CLOs represented by J.P. Morgan CLO AAA Index. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities mentioned herein.
While CLO metrics remain strong overall and spreads tightened over the course of the fourth quarter, CLO spreads remain materially wider than both the beginning of the year and the median level seen over the past five years as ongoing geopolitical and economic risks continue to weigh on market sentiment. As we expect the pace of downgrades to pick up in 2023, we continue to shift portfolios higher in the capital stack and out of CLOs with high levels of B- exposure.
Outlook Ahead: Holding Defensive Position as Uncertainty Continues
CLOs ended the year on a positive note; however, the Fed quickly warned markets they aren’t finished tightening financial conditions, which could result in additional volatility in the first half of 2023. We remain of the view that credit is entering a slowdown from a point of strength. While fundamentals for leveraged finance issuers are starting from a strong position, the macroeconomic environment indicates a flattening of fundamentals at best, with some likely deterioration. We expect leveraged loan default rates to trend higher from here and move towards longer-term asset class averages. A more challenging macroeconomic backdrop, higher Treasury rates, wider spreads, and a less receptive capital markets environment all contribute to our expected increase in default rates. From a technical standpoint, we believe demand for CLOs will continue to be robust as negative real rates will continue to incentivize investors to take advantage of the yield pickup and the relative attractiveness of CLOs compared to other credit assets. As a result, we expect spreads to remain largely range bound, although spreads are currently near the tighter end of our expected range.
With the new year comes one of the most anticipated recessions in history. While we see some opportunities to add risk on the margin, given the level of uncertainty in the market and tight credit spreads, we do not believe this is the time for broad risk-on positioning. Instead, we believe rallies will provide a good opportunity to further reduce risk and favor our prior stance of maintaining marginally defensive positioning, looking to add relative value at the security and manager selection level.
| Average Annual Total Returns (%) as of December 31, 2022 | ||||||||
| 1 Month* | 3 Month* | YTD | 1 Year | 3 Year | 5 Year | 10 Year | LIFE6/21/2022 | |
| CLOI (NAV) | 1.06 | 3.16 | — | — | — | — | — | 3.26 |
| CLOI (Share Price) | 0.88 | 2.20 | — | — | — | — | — | 3.55 |
| J.P. Morgan Collateralized Loan Obligation Index | 0.81 | 3.03 | — | — | — | — | — | 2.69 |
* Returns less than one year are not annualized.
Van Eck Associates Corporation (the “Adviser”) will pay all expenses of the Fund, except for the fee payment under the investment management agreement, acquired fund fees and expenses, interest expense, offering costs, trading expenses, taxes and extraordinary expenses. Notwithstanding the foregoing, the Adviser has agreed to pay the offering costs until at least May 1, 2024.
The performance data quoted represents past performance. Past performance is not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Performance may be lower or higher than performance data quoted. Please call 800.826.2333 or visit vaneck.com for performance current to the most recent month ended.
The “Net Asset Value” (NAV) of a Fund is determined at the close of each business day, and represents the dollar value of one share of the fund; it is calculated by taking the total assets of the fund, subtracting total liabilities, and dividing by the total number of shares outstanding. The NAV is not necessarily the same as the ETF’s intraday trading value. Investors should not expect to buy or sell shares at NAV.
DISCLOSURES
Index descriptions:
J.P. Morgan Collateralized Loan Obligation Index (CLOIE) is comprised of US dollar denominated broadly syndicated arbitrage CLOs.
AAA Rated CLOs represented by J.P. Morgan CLO AAA Index is a subset of the CLOIE index that only tracks the AAA rated CLO.
AA Rated CLOs represented by J.P. Morgan CLO AA Index is a subset of the CLOIE index that only tracks the AA rated CLO.
A Rated CLOs represented by J.P. Morgan CLO A Index is a subset of the CLOIE index that only tracks the A rated CLO.
BBB Rated CLOs represented by J.P. Morgan CLO BBB Index is a subset of the CLOIE index that only tracks the BB rated CLO.
BB Rated CLOs represented by J.P. Morgan CLO BB Index is a subset of the CLOIE index that only tracks 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 U.S. dollar-denominated below investment grade corporate debt publically issued in the U.S. domestic market.
ICE BofA US Broad Market (US00) tracks the performance of US dollar denominated investment grade debt publicly issued in the US domestic market, including US Treasury, quasi-government, corporate, securitized and collateralized securities.
JP Morgan Leveraged Loan Index is comprised of U.S. dollar leveraged loans.
Morningstar/LSTA Leveraged Loan Index is comprised of U.S. 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 involve the rendering 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, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its employees.
An investment in the VanEck CLO ETF (CLOI) may be subject to risks which include, among others, Collateralized Loan Obligations (CLO), debt securities, LIBOR Replacement, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund, management, derivatives, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, new fund, absence of prior active market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, and seed investor risks. The Fund may also be subject to liquidity, interest rate, floating rate obligations, credit, call, extension, high yield securities, income, valuation, privately-issued securities, covenant lite loans, default of the underlying asset and CLO manager risks, all of which may adversely affect the Fund.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Funds carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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