2 Options to Capture the Complexity Premium in CLOs

In a Q2 Market Outlook Symposium with TMX VettaFi, and John Kim, CEO of Reckoner Capital Management, it was noted that collateralized loan obligation (CLO) ETFs have captured roughly $6 billion in inflows year to date. One of the notions discussed in the symposium is the “complexity premium” tied to CLOs. “We think most people who do understand them love that complexity premium,” Kim explained. He noted that investors essentially capitalize on their understanding of an asset class not yet fully adopted by the retail investor market.

As individual investors seek higher yields without the risks associated with traditional fixed income assets like corporate bonds, the actively managed Reckoner Yield Enhanced AAA CLO ETF (RAAA) and the Reckoner BBB-B CLO ETF (RCLO) emerge as compelling options. Not only do these funds provide the bridge between institutional strategies and retail investors, they seek to provide that complexity premium that Kim mentioned. For many investors, the primary barrier to entry for structured credit is a lingering misconception born of the 2008 financial crisis. Kim was quick to clarify that CLOs — backed by broadly syndicated corporate loans —have historically performed well through the crisis compared to subprime mortgages that were popular at the time. “AAA CLO bonds, for example, have never had a default in their 30+ year history,” Kim noted, which speaks to the opportunity that RAAA presents to investors.

RAAA focuses on the senior-most tranches, but works to add a strategic yield advantage compared to its peers. The fund employs leverage to seek to enhance its yield. That allows the fund, according to Kim, to “seek to outperform our unlevered peers” and also seeks to provide a “better proxy for corporate risk.” Investors desiring to move down the capital stack, aiming to achieve higher income, should take a closer look at RCLO. This mezzanine fund invests in Triple-B and BB-rated CLO bonds, which have higher yield potentials. Mezzanine tranches are naturally more sensitive to market shifts compared to AAA-rated debt. However, Kim emphasized the security of the broadly syndicated loan market. In contrast to private credit headlines causing anxiety in the 24-hour financial news cycle. RCLO takes a differentiated approach by focusing on liquid, bank-underwritten loans.

Both funds are actively managed. RAAA and RCLO access the expertise of Reckoner Capital’s portfolio managers to seek to benefit from the complexity premium. The managers have experience in how to navigate the CLO market in any macro environment. Indeed, Reckoner Capital has deep expertise and operates as specialists in the nuanced CLO market. As the CLO ETF market sees greater adoption, Kim’s outlook is clear. CLOs are becoming less of a niche, satellite position. By replacing traditional corporate exposure with the floating-rates and higher relative yield potential found in RAAA and RCLO, advisors can implement a “better policy” for credit risk in a higher-for-longer rate environment.