What are Collateralized Loan Obligations (CLOs)?

Mark Shohet

A collateralized loan obligation or a CLO is a type of securitization where the underlying collateral is a pool of diverse, sub-investment grade corporate loans. Those loans form the assets of the CLO. Liabilities are then issued against those assets. And those liabilities come in the form of debt tranches that are issued to investors.

So a CLO investor has the option to buy a CLO tranche in the capital structure where they choose down from AAA, which is the lowest return and lowest risk part of the capital structure, all the way down to the mezzanine parts of the capital structure. So quite simply, a CLO gives an investor the ability to be exposed to a pool of corporate loans.

But then the investor then gets to choose where in the capital structure they want to play and what type of risk return profile they want to achieve.

Why are CLOs a compelling investment now?

Mark Shohet

I think the main reason right now why CLOs are so compelling is because, particularly if you play at the top of the capital structure, you are very immune from some of the idiosyncratic credit stories that may occur in a portfolio. So you have a very large cushion to defaults, which in this current macro environment where we obviously have a ton of uncertainty of the macro picture, of the rates picture and what may happen to single name credit stories, it's very beneficial for an investor to play at the top of a capital structure and feel very comfortable that they have a very large cushion to defaults.

And, because of the way CLO vehicles work, there's very, very high defaults that would need to occur in a CLO portfolio to impact someone in the IG capital structure, and even more so at the very top of the capital structure in triple As. In fact, no triple A tranche has ever experienced a default. So that speaks to the very high cushion to defaults you get within the CLO vehicle at the top of the capital structure.

In addition, CLOs are floating rate instruments. So in this current rate environment, whether you believe we will continue to be in a higher for longer world or you just don't want to take much duration exposure, being invested in a floating rate vehicle allows you to have very minimal interest rate duration, which can be very beneficial and very compelling to a lot of investors out there who don't want to take that interest rate, duration risk right now.

And lastly, you know, you have, given the high cushion to defaults and the minimal duration, you have very attractive spreads and yields versus comparable, corporate investments. So even with allof those benefits, you're actually being compensated more than comparable corporate securities. So I think the combination of those three is what is making the asset class very compelling, and why we're seeing so much capital be added to the space right now.

Tell us about the RBC AAA CLO (CAD Hedged) ETF (RCLO)

Mark Shohet

So this ETF is newly launched. And I think what's most exciting about it is it gives the retail investor the ability to access the CLO product, which historically has been reserved for the institutional investor base. So it is a way for the investor to access very high quality, triple A type risk with strong structural protections and attractive yields versus comparable government or corporate bonds.

And of course, as you mentioned, it is fully CAD hedged. So it's an attractive way for Canadian investor to access the CLO product in a currency hedged vehicle.

How could investors think about using RCLO in their portfolio?

Mark Shohet

So the first way I think is it can be added to a core portfolio to improve the credit quality of a portfolio, to add some diversification. Of course, this is a floating rate product, so whether it's to minimize duration in a portfolio, whether it's to add some, diversification in kind of a sector or a product. I think RCLO allows an investor to do that.

And secondly, it can just of course, be used as a standalone product to provide, attractive, high quality and high yield investment, in a, you know, standalone portfolio. And then lastly, it can of course be used kind of as a hybrid and to be added together with other higher yielding fixed income securities where the negative correlation of the asset class will kind of improve overall returns and diversification.

Why is the BlueBay Fixed Income team well positioned to manage RCLO?

Mark Shohet

I think the main point to get across is that the BlueBay fixed income team is by no means new to CLO investing or securitized credit investing. So, while the RCLO ETF is a new product, our team has a depth of expertise and relationships that we formed over the course of many years, given our current positioning in the marketplace. So just to give you some context and some numbers, we manage about $9 billion of AUM within our securitized credit platform, about $2 billion of that is in high grade or investment grade strategies, very similar to this, RCLO ETF. So, we already established those relationships on the dealer secondary desk on the primary desk. Very often we are the first call, whether it's in the U.S. or Europe, because of our long standing relationships in these marketplaces.

And then we have about $4 to 5 billion of CLO AUM that's CLOs that we manage. And given how big we are in that part of the market, we're able to leverage the expertise from our CLO portfolio managers within our leveraged loan business. So, I think we have a very experienced team, and I think that we're able to utilize the large size of the platform and the fact that we've been doing this a very long time.