[Talk ETFs] How to Capture High Yields With CLO ETFs

Summary

In this video, John Kim, CEO and Co-Portfolio Manager of Panagram, discusses the investment opportunities and nuances of CLO (Collateralized Loan Obligation) ETFs, specifically CLOX and CLOZ. He explains the difference between the two ETFs—CLOX invests in AAA-rated bonds, offering a super-secure investment option, while CLOZ focuses on lower-rated, higher-yielding bonds. John highlights the impact of interest rates, the economy, and credit spreads on CLO investments. He also advises investors on incorporating CLOs into a diversified portfolio, offering strong alternatives to traditional high-yield bonds and cash investments. The video wraps up with a nod to Panagram's recognition as a finalist for ETF Issuer of the Year.

Takeaways

• 😀 CLOs (Collateralized Loan Obligations) are securitized corporate loans that differ from CDOs, which are based on mortgages. CLOs are considered a safer investment, especially during economic downturns.
• 😀 CLO bonds are typically senior and secured, meaning they are prioritized in terms of payment and collateralized by the company's assets, offering a higher level of protection to investors.
• 😀 CLOX invests in AAA-rated CLO bonds, which are seen as extremely safe and have never defaulted, offering high security similar to government bonds.
• 😀 CLOZ invests in lower-rated bonds (BBB and BB), which carry more risk but also offer higher yields, with current SEC yields around 10%.
• 😀 CLO bonds are floating-rate instruments, meaning their interest payments are tied to prevailing interest rates. Rising rates increase yield, while falling rates lower it, though the credit spread remains a crucial factor.
• 😀 The CLO market has grown significantly over the last 20 years and is now over $1.5 trillion in size, with CLOs being a great way to access corporate lending.
• 😀 CLOX is ideal for investors looking for a safe, senior exposure to CLO bonds with little risk, while CLOZ offers a higher risk/higher reward profile for those willing to engage in more aggressive credit analysis.
• 😀 CLO bonds provide downside protection through diversification. For example, a CLO investor could suffer losses only if a significant portion of the loans (12-14 loans for AAA-rated CLOs) defaults, which is highly unlikely.
• 😀 The performance of CLO bonds is influenced by the economic environment, including interest rates and corporate defaults, but the diversification within CLOs mitigates individual loan defaults.
• 😀 CLOs are recommended as a permanent component in diversified portfolios, serving as an alternative to high-yield bonds or as a cash substitute, particularly CLOX for safer cash-like investments.
• 😀 The interview highlights that Panogram, the issuer of CLOX and CLOZ, focuses on niche credit markets and has been recognized for its expertise in CLOs, receiving a nomination for ETF issuer of the year.

Q & A

What are CLOs and how do they differ from CDOs?

CLOs (Collateralized Loan Obligations) are a type of security backed by a pool of corporate loans, offering a way for investors to access senior, secured corporate lending. They are different from CDOs (Collateralized Debt Obligations), which were based on mortgages and played a role in the 2008 financial crisis. CLOs are based on corporate loans, which have proven more stable than CDOs.

What are the key characteristics that make CLOs an attractive investment?

CLOs are attractive because they are backed by senior, secured corporate loans, meaning they have priority over other forms of debt in case of company bankruptcy. This provides a level of protection against defaults. Additionally, CLOs offer floating interest rates, which allow investors to benefit from rising interest rates.

How do CLOs perform during periods of economic uncertainty?

During economic uncertainty, CLOs generally perform well due to their senior and secured position in a company’s capital structure. Even if a company faces financial difficulty, it still has to service its senior secured loans. This gives CLOs a level of protection against economic downturns compared to other high-risk bonds.

What is the difference between the CLOX and CLOZ ETFs?

CLOX focuses on AAA-rated CLO bonds, which are the highest-rated and the safest in terms of default risk. CLOZ, on the other hand, targets lower-rated bonds (BBB and BB), which offer higher yields but come with slightly more risk. CLOX is ideal for those seeking stability, while CLOZ appeals to investors willing to take on more risk for higher returns.

What impact do interest rates have on CLO ETFs?

Interest rates directly affect CLOs because they are floating-rate instruments. When interest rates rise, the yield on CLOs increases, which can benefit investors. Conversely, if rates fall, the yield decreases, but CLOs still offer a strong credit spread, meaning they can maintain attractive returns even in a lower-rate environment.

How do CLOs protect investors in case of company defaults?

CLOs provide protection by pooling multiple loans together, meaning investors are not exposed to the default of a single company. If a company defaults, the loss is shared across the pool, and as a result, investors in higher-rated CLOs (like CLOX) have a lower risk of loss, with a larger number of loans needing to fail before the investor experiences a loss.

Why are CLOs considered a good alternative to high-yield bonds?

CLOs are considered a better alternative to high-yield bonds because they are secured and senior, offering a higher level of protection. While high-yield bonds can be riskier and subordinated in the capital structure, CLOs provide more stability and can deliver competitive returns, especially in rising interest rate environments.

What makes CLOs a suitable replacement for cash in investment portfolios?

CLOs, particularly CLOX (AAA-rated), are a good replacement for cash because they are extremely secure, senior in the capital structure, and yield a higher return than typical cash-equivalent investments like money market funds or short-term bonds. The security and liquidity of CLOX make it an ideal substitute for low-yielding cash reserves.

How do Panogram’s CLO ETFs stand out in the market?

Panogram’s CLO ETFs stand out due to their focused expertise in the CLO space. They specialize in credit products, with CLOs being one of their core offerings. The firm emphasizes a deep understanding of the market, focusing on high-quality, senior-secured CLOs to provide both security and attractive yields for investors.

What role do CLOs play in a diversified investment portfolio?

CLOs play an important role in diversification by providing exposure to corporate loans, which offer a unique risk-return profile compared to other asset classes like equities or fixed-income bonds. CLOs, especially those like CLOX (AAA-rated), offer security and predictable returns, making them a stable component of a diversified portfolio.