So far in 2021, collateralized loan obligations (CLOs) have been the best-performing asset class across U.S. fixed-income sectors. Returns for CLOs are catching up to more duration-sensitive sectors, such as corporate bonds, in this year’s rising-rate environment. AAA CLOs have returned 0.73% year-to-date and outperformed investment-grade (IG) corporate returns of -2.0%.
In the first half of this year, we saw robust new issuance and refinancing volume. I expect that trend will continue throughout 2021, given the strong demand and low liability cost to incentivize managers print deals.
Moving ahead, the dramatic spread tightening since the second quarter of 2020 across all fixed-income sectors is likely to slow. Having witnessed the second quarter of U.S. fixed-income spreads trading near the tightest levels since the great financial crisis, I expect that CLO valuations will continue to be supported by a robust economic backdrop and its resilience to higher inflation due to the floating-rate structure. Moreover, AAA CLOs had a 0.0% downgrade rate versus 6.8% for IG corporate during 2020. CLOs once again demonstrated their structural protections to reduce downgrade and default risks.
This week’s chart compares AAA CLO spreads versus IG corporate bonds since 2012. The chart demonstrates that the ratio of AAA CLO spreads to IG is at the high end of the recent range, highlighting the attractiveness of high-quality CLOs. Positioning in AAA CLOs benefit a solid carry on a relative value basis.
Federal Reserve (Fed) Chair Jerome Powell delivered a more hawkish tone during the June Federal Open Market Committee meeting. As a result, I believe high-quality floating-rate assets, such as AAA-rated CLOs, are likely to continue their recent outperformance as the Fed begins the process to reduce bond purchase activity and increase short-term rates.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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