For Downturn Protection, Consider CLO ETFs

During periods of elevated market stress, including those that see pinched corporate bonds, collateralized Loan Obligations (CLOs) often outperform other corporate bond assets. Add to that, CLOs often emerge from those rough patches in strong form, delivering impressive returns a year after downturns. CLOs’ history may be a sign that advisors and investors seeking dependable income and protection should evaluate ETFs such as the VanEck CLO ETF (CLOI) and the VanEck AA-BB CLO ETF (CLOB).

Data confirm that market participants should consider fixed income ETFs like CLOI and CLOB in advance of trying market settings. In a recent report, VanEck product manager Nicolas Fonseca examined five periods of market duress, including the 2013 taper tantrum, the 2018 bear market caused by a trade war with China, and the 2020 coronavirus bear market, discovering that CLOs are typically moved less by headlines and more “by the type of stress in the markets.”

CLOs Often Hold Up Well

The actively managed CLOI, one of the original ETFs addressing CLOs, debuted four years ago, so it wasn’t around during the 2013 taper tantrum. However, that was a period in which highly-rated CLOs proved somewhat durable while delivering solid returns a year later. That’s pertinent in discussing CLOI because the VanEck ETF devotes about 80% of its roster to CLOs rated AAA, AA or A. It implies that, if another taper tantrum or similar event materializes, CLOI could prove sturdy.

The COVID-19 bear market was a different ballgame. CLOs, including highly rated fare, struggled during the worst days of the pandemic. However, CLOs that CLOI would have likely held, had the ETF been around then, delivered stellar returns in mid- to late 2021.

“Prices declined sharply during the height of the crisis, reflecting forced selling rather than a reassessment of long-term credit fundamentals,” noted Fonseca. “After the Fed supported the market and restored liquidity, recoveries were quick, with 12-month returns following peak drawdowns among the strongest on record.”

The Federal Reserve’s rate-tightening campaign, which started in 2022 and lingered into 2023, could also prove instructive regarding how ETFs such as CLOB and CLOI could perform should the central bank enter another period of rate hikes.

“Unlike duration-sensitive bonds, CLOs benefited from higher base rates, which helped offset spread volatility and limited drawdowns relative to traditional credit,” added Fonseca. “While price pressure lasted longer than in prior episodes, cumulative returns remained competitive and recoveries were steady, showing the advantages of floating-rate exposure in a rising rate environment.”

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