Where to go for double-digit returns

The hottest thing about capital markets is something that few mutual fund investors know about, and those who do tend to avoid it. But the surprisingly high returns – up to half the year – make these typically institutional investments worth another look.

These instruments are Secured Loan Bonds, or CLOs. For individual investors, they’re mostly the preserve of a few closed-end funds, or CEFs, and used sparingly in a handful of open-end mutual funds. A CLO is a credit derivative, made up of leveraged business loans, making them first cousins ​​of junk bonds. But leveraged loans pose less risk than these bonds on two fronts. First from the point of view of credit, because loans are paid before bonds and stocks, but also from the point of view of interest rates, because loans are generally at variable rates and therefore do not fall in price when rates rise, as do fixed rate bonds.

CLOs are made up of loans cut into slices. The higher debt tranche is paid first and therefore is the least risky and least profitable, with each subsequent tranche being paid more to be further back in the queue. Finally, there is the “equity” tranche, which gets the greatest rewards for the greatest risk.

All of these can sound a lot like secured debt securities, or CDOs, among the things Warren Buffett called “financial weapons of mass destruction” before they exploded dramatically during the credit crunch in him. ten years ago. Except secured loan bonds haven’t collapsed like CDOs.

Subprime mortgages were the toxic CDOs – sow ears masquerading as silk stock market credits, with similar price markups – that collapsed during the financial crisis. But because CLOs were backed by senior loans, they didn’t endure the cascade of defaults that plagued CDOs. Leverage loans have grown in popularity, overtaking junk bonds for the first time in a decade, according to data from Fitch Ratings. The total of these loans increased by $ 33 billion in May, to reach $ 1.22 trillion, according to the Wall Street Journal. reports.

The popularity of CLOs has been a major driver of the lending surge, as institutional investors have been drawn to their lower interest rate risk as the Federal Reserve tightens policy and economic expansion supports companies issuing loans. According to Bank of America Merrill Lynch, CLO’s issuance for the year through June 8 totaled $ 56.4 billion, more than $ 39.7 billion for all of 2017.

For individual investors, the closed fund structure offers significant advantages for illiquid assets such as loans or CLOs. Mutual funds have to deal with redemptions, which means sticking to highly liquid assets that they can easily sell. Closed-end funds have a fixed number of stocks that investors buy and sell to each other, so the manager does not need to adjust the portfolio to account for inflows or outflows.

But should you have one? It depends, first, on your tolerance for risk, and second, on the type of CLO investment you choose. Two closed funds,



Eagle Point Credit

(ticker: ECC) and



Capital of Oxford Lane

(OXLC), focus on equity CLOs, the riskiest but most profitable tranches, with returns of up to 15%.



XAI Floating Rate Alternative Income Octagon Term Trust

(XFLT) is more conservative, using the debt and equity of the CLO as part of an overall loan portfolio, with a return of around 9% lower.

“I challenge you to find a better asset class,” says Thomas Majewski, who heads Eagle Point Credit Management, of CLOs. Even during the credit crunch, 96% of the tranches of shares issued in 2006-07 were redeemed. This is a testament to the security offered by the underlying senior loans.

The XAI Octagon fund focuses on what Kimberly Flynn, Managing Director of Alternative Investments at XA Investments, calls an institutional strategy that never goes 100% CLO stocks, but uses debt and CLO stocks to improve performance. returns and provide diversification in a credit portfolio. Although its return is lower than that of CLO equity funds, it offers a higher return to financial advisors who would typically look to an exchange-traded fund with senior floating rate loans, such as the



Invesco Senior Loan

ETF (BKLN). XAI Octagon is designed as a liquid alternative investment, uncorrelated to stock or bond markets, she adds.

Nothing


Greg Peters, senior portfolio manager at PGIM Fixed Income, favors CLOs for the credit portfolios he helps manage. He prefers the highest quality AAA tranches, as opposed to the softer ones demanded by yield-hungry investors. Indeed, in structured finance, if one part is put on the rise, the others should be relatively less expensive, he explains.

This rich price also extends to closed-end funds which focus on high yielding, but riskier equity CLOs. Oxford Lane and Eagle Point are trading at premiums to their net asset values, but at prices significantly lower than their recent highs. The low yield XAI Octagon fund went public last September and is only trading at a low discount.

What all of these closed-end funds have in common are high expense ratios, even by CEF standards. The funds claim that this reflects the significant research needed to select secured loan bonds. But the high fees will only be worth it if the funds continue to provide high returns when the credit cycle becomes less favorable.

Write to Randall W. Forsyth at [email protected]

Source link

About Travis Durham

Travis Durham

Check Also

Moments – Presents several versions of Blockchain

MILTON KEYNES, UK, April 01, 2021 (GLOBE NEWSWIRE) – Moments, a third-generation open source blockchain …

Leave a Reply

Your email address will not be published. Required fields are marked *