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While familiar to institutional investors, collateralized loan obligations (CLOs) are relatively new territory for many Canadian financial advisors. But the door is opening to CLO access for retail investors.
It’s an opportune time to consider CLOs. In today’s uncertain interest rate environment, advisors are under pressure to uncover new income opportunities without sacrificing quality or stability. “We think high-quality CLOs fill that gap,” says Aaron Young, Executive Director and Head of Client Portfolio Management with CIBC Asset Management.
A CLO is a credit product that pools corporate senior loans into a single package. The loans generate cash flows that form the CLO structure. CLOs are divided into tranches with different risk and return levels.
As the fixed income landscape evolves, advisors are rethinking traditional strategies. High-quality CLOs — when actively managed and carefully structured — offer a rare combination of yield, quality, and resilience.
The launch of the CIBC Income Advantage Funds can help meet the need for a prudent and institutional-calibre income solution.
Built on strict underwriting standards
Some advisors and investors associate the acronym CLO with the structured products that helped trigger the 2008 financial crisis. But there are crucial differences between CLOs and that period’s CDOs (collateralized debt obligations).
CLOs aren’t built on subprime mortgages, or any mortgages, notes Young. They comprise loans that are typically made to large and midsize U.S. companies, including household names like American Airlines and Burger King. “They’re blue-chip companies we know well,” he says.
CLOs follow strict underwriting standards. Moreover, CLOs weathered the financial crisis thanks to their conservative structuring. The latest iterations, sometimes called CLO 2.0, feature even more robust safeguards and high-quality inputs.
CLOs represent a USD $1.2-trillion market globally. That’s bigger than Canadian government, provincial, and corporate bonds. The majority of CLOs are AAA-rated securities, representing about 60 percent of the market. In the case of the CIBC Income Advantage Funds, the exposure is at least 80 percent AAA, and will probably be closer to 85 to 90 percent. The remainder are AA- and A-rated securities.
High-quality CLOs like these have a solid track record, even during periods of market stress. “That speaks to the quality of these instruments,” says Young.
Increased potential for yield
CLOs are particularly compelling given today’s backdrop of rate volatility and tightening spreads. One of the best reasons to consider CLOs is their yield potential.
Compared to traditional fixed income, AAA-rated CLOs have consistently offered higher income without meaningfully increasing risk. An investor with a core bond portfolio made up of government and corporate bonds can possibly achieve higher overall portfolio income by adding an allocation to a CLO fund.
Balanced and growth investors can benefit, too.
For balanced investors, CLO funds offer access to a broader range of fixed income assets — compared to the traditional stock and bond mix — to help manage risks and reduce overall portfolio volatility.
Growth investors might also be looking for ways to earn higher income without taking on excessive equity risk. These funds introduce an income-generating asset class that complements their long-term growth strategies.
CLOs are floating-rate instruments, so they also offer built-in protection against interest rate volatility while still offering predictable cash flows.
Complementing a core allocation
This isn’t about replacing traditional holdings but augmenting them, says Young. Government, corporate, and high-yield bonds remain the foundation of fixed income portfolios. “A CLO fund is a great complement to sit alongside that core allocation.”
Young notes that, historically, CLO sleeves have shown low-to-zero correlation with core bond portfolios. This is valuable to advisors who want to build portfolios designed to “zig when one zags,” he says.
AAA-rated CLOs are primarily held by major banks, insurance companies, and pension funds. CIBC Income Advantage Funds invest in CLOs by taking a similar approach.
“We’re following the playbook of institutional investors,” says Young.
In this case, to capture income advantages often unavailable to individual investors. To do so, the CIBC Asset Management team focuses on three layers of risk management. They take a deep dive on: 1) the underlying loans in the CLO instruments; 2) the CLO managers (“We’ve covered them for decades and have seen them through cycles,” Young says); and 3) the structuring of a CLO to ensure it aligns with risk-return goals.
The CIBC Income Advantage Funds leverage over 50 years of CIBC Asset Management’s experience as an active fixed income investor, with specialist research teams and a dedicated credit analysis team. As a distinct asset class, CLOs offer investment opportunities that may not be available through traditional fixed income options. Through rigorous due diligence and a disciplined approach, CIBC Asset Management aims to deliver high-quality income and diversification that advisors can confidently recommend — in uncertain times and beyond.
