November 11, 2025 • 44 mins
A potential shift in US monetary policy toward fiscal dominance — where government financing influences rates more than inflation control — could change the risk-return trade-off for CLO investors. In this episode of Inside Active, host David Cohne, mutual fund and active management analyst with Bloomberg Intelligence, along with co-host Reto Bachmann, BI’s chief structured finance strategist, spoke with Bill Sokol, director of product management at VanEck and Fran Rodilosso, head of fixed income ETF portfolio management and a portfolio manager on the VanEck CLO ETF (CLOI) and VanEck CLO AA-BB CLO ETF (CLOB), about why active management is essential when it comes to manager selection and loan-level analysis and how effective ETF management mitigates liquidity risk through diversified exposure across tranches. They also discussed why relative value remains attractive as CLO tranches yield more than corporates and other asset-backed securities.
This podcast was recorded on Nov. 4.
See omnystudio.com/listener for privacy information.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:14):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges, and philosophies and security selection. I'm David Cohne,
i lead mutual fund and active Research at Bloomberg Intelligence.
Today my coast is Rehdel Bachmann, Chief structured finance strategist
at Bloomberg Intelligence RADDA. Thank you for joining me as
(00:34):
my coast today.
Speaker 2 (00:35):
Oh, it's my pleasure.
Speaker 1 (00:37):
So since our discussion today is going to be on CLOS,
I did want to ask about a note you put
out recently about USCLO structural performance. Can you give our
listeners a brief overview of how current fiscal policy could
affect CLO returns?
Speaker 2 (00:53):
Yes, So that was something I wanted to alert CLO
investors too, because it's something it's a kind of risk
that they might not be used to. In the West.
Have been used to central banks running orthodox monetary policies,
which means that they're very much focused on price stability.
They may have other objectives as well, but price to
bility is certainly a key one, and as a result
of that, what we expect to happen when inflation goes
(01:14):
up is that policy rates also go up, and vice versa.
So our presumption tends to be that foreign nodes, including
ef ends, including clos are effectively sort of inflation hedged.
When inflation goes up, yes, the principle becomes less valuable
in real terms, but as policy goes up, floating rates
(01:36):
go up, and as a result, coupons go up, and
then the higher couponts compensate for the loss of the
real value in the principle. So that's how we used
to think about it. Of course, if you're an emerging
markets investor, then you're used to different types of monetary policies,
especially physically dominated monetary policies. These are situations where the
government is really dictating monetary monetary policy, usually with a
(01:59):
view to enabling the funding of the state. And so
what happens under these regimes often is that inflation is higher,
but despite that, interest rates are lower than there would
be under orthodox minetary policy, and all of a sudden,
when that happens, and when you're under that regime, then
the clos are no longer effective for inflation headed because
(02:20):
what happens is that inflation goes up the floating rates
don't go up, so the coupons don't go up, and
as a result of that, you don't get compensated for
the loss in the real value of the principle. And
of course, currently we have the situation in the US
where there's a wankling over ultimately what the monetary policy
should be. The FED, at least so far, seems to
be more leaning towards the orthodox minetary policy to some extent,
(02:44):
and of course the administration would like to have a
monetary policy that's more focused on funding the state, lower
interest rates and higher inflation. And so this is going
to change, especially if we do end up in a
situation where we have a fully physically dominated monetary policy
in the US. Yes, that's going to change the risk
return trade for clos, and then there's a discussion about
(03:05):
how exactly that would affect clos. The collateral performance will
will be good because the borrowers in the colateral pull
on the same situation as the state. They benefit from
an erosion of the real value of the principle that
they owe, and they benefit from having to pay low
interest rates because the loans are also floaters. And of
course from a structural perspective, the CELO wouldn't be much
impact it because the structure itself doesn't have interested exposure
(03:28):
because both the liabilities and the assets of floaters. But
for the COLO investors, the brisk returns of period of
are very different under fiscal dominance than they are on
the orthodox minitary policy.
Speaker 3 (03:40):
Yeah.
Speaker 1 (03:40):
Interesting, Well, I'm sure our guests today could also provide
some color into that. So out further ado, I'd like
to welcome friend Rodoloso and Bill so calls Inside Active.
Bill is director of product Management at VNAC, and Fran
is head of Fixed Income ETF portfolio Management at VNACK
and a portfolio manager on the VNAC CLO ETF and
(04:01):
the AA B B c l O ETF ticker c
l O I in c l O B. Brandon, Bill,
thank you so much for joining us today.
Speaker 3 (04:10):
It's great to be here. Thanks David, thanks for having us.
Speaker 1 (04:13):
To get started. I'll go first to you. Bill. Can
you walk us through the main investment thesis for CLO
I in cl O B.
Speaker 3 (04:21):
Yeah, of course.
Speaker 4 (04:22):
So, you know, I think for both funds the thesis
is really that CLOS can help build a stronger bond portfolio.
And that all investors should have access to clos and
of course that wasn't really the case until we started
seeing these ETFs launch, But so that that's one aspect
of the other is that, you know, we believe you
(04:43):
can achieve better outcomes by not constraining yourself to a
single rating category, and that you really do need to
take an active approach in this market. So as far
as you know, the constraining yourself to a single rating category,
you know, if you look at the the COLO market
today and historically it's been dominated by institutional investors and
(05:06):
they do tend to focus on single ratings. So banks
are the biggest investors in clos and certainly the biggest
in triple a's, and you're not really going to see
them going to mezzanine tranches. And the reason is that
they're highly regulated, they have regulatory capital constraints, and really
only triple as makes sense for them. But when when
(05:28):
we were thinking about launching our funds, you know, we
took the approach that you know, most investors don't have
these constraints and you can get more income and find
additional opportunities if you can take advantage of the whole
capital structure. So both of our ETFs are based on
this idea that you know, if you can invest broadly
(05:48):
and take advantage of that capital structure that the CLO has.
Speaker 3 (05:52):
You can you can have better outcomes.
Speaker 4 (05:54):
And uh col I focuses on investment grade tranches and
we think that it's a useful strategy within a broader
core bond portfolio, and we also offer COLOB which focuses
on mezzanine tranches, so primarily double A to double B.
So it's, you know, it's a higher returning potential but
(06:16):
also higher risk strategy that we think can be a
good compliment a high yield.
Speaker 1 (06:22):
So you mentioned, you know, it's typically institutional investors that
have had access to these Who's the target investor for
these to ETFs? Is it you know everyone or are
you kind of looking to get more of retail investors involved.
Speaker 4 (06:36):
Well, you know, I'd say there's not necessarily one type
of target investor necessarily, and I think that's one great
thing about the ETF is that all types of investors
can can buy it and have the same exposure at
the same cost.
Speaker 3 (06:52):
You know.
Speaker 4 (06:52):
That being said, in our funds, we've primarily seen interests
and aum come from the wealth channel, so this is
this is r as SO registered investment advisors and also
advisors that you know, broker dealers, including some of the
big wirehouses that you know that everyone knows. And these
(07:13):
of course are investors who haven't really had access to
celos before these etf started launching, certainly not in a
liquid vehicle. So so for many of these investors it's
the first time they're they're learning about celos and and
have the opportunity to add them into their portfolio. UH.
(07:33):
We have also seen a pretty sizable interest from institutional
investors as well in RTF and primarily that's the insurance market,
so insurance general accounts, and unlike the wealth channel, you know,
for many of these insurance companies, celos are not new.
These are insurance companies in general are big investors in
(07:53):
celos and and often they they may have invested directly
with COLO tranch manager, but with ETFs, you know, in
smaller portfolios or with smaller insurance companies, you know, an
allocation to a separate account with a CLO tranch manager.
(08:14):
UH maybe was too large for some of these smaller portfolios.
So the ETFs are are great to get that exposure.
I think we're also seeing the ETFp used as part
of a broader COLO allocation. So sometimes these general accounts
are buying clos directly or or maybe through a separate account,
(08:36):
but they're using the ETF alongside those holdings as a
liquidity sleeve. So so it's a way to optimize liquidity.
Speaker 2 (08:43):
Yeah.
Speaker 1 (08:44):
Now my next question could be for either one of you,
how do you define the market opportunity for CLO tranches today?
Speaker 5 (08:53):
They'll do I'm gonna lead off. I'll say say this,
there's a relative value opportunity to begin with. So if
you compare the higher rated tranches versus other forms of abs,
you know, the CLO tranches are going to offer a
more attractive spread than almost all the other alternatives, and
(09:14):
certainly versus investment grade corporates at any step along the
rating scale, a meaningful pickup in yield. So just in
general from an allocation perspective, of course, with the floating
rate nature, you can add yield and reduce duration in
your portfolio, you know, thereby reducing one form of risk.
(09:37):
So we think with you know, investment grade clos, there's
this opportunity to really add some kind of permanent allocation
to enhance overall, you know, your sharp ratio basically, you know,
in terms of today sort of bottom up opportunities or
relative value within.
Speaker 3 (09:57):
The CLO market.
Speaker 5 (10:00):
Certainly, spreads have compressed in every corner of the credit
market in general. And although COLO spreads are wide on
a relative versus other asset classes, it's not a time
we believe, Nor by the way we work with the
subadvisor on these funds, Pine Bridge, who's got very deep
experience in this space, we're both in agreement this is
(10:23):
not a time to go too far down the credit
spectrum in order to add yield, So a more conservative
approach is warranted. But there are plenty of bottom up opportunities.
You can still find value in the secondary market and
some of the lower rated tranches, more so in the
(10:44):
primary market, where the spreads are still slightly more attractive
in the higher rated tranches. But that type of positioning
right now should still provide an attractive yield to investors
versus most other alternatives in the income space.
Speaker 3 (11:01):
Yeah.
Speaker 1 (11:02):
And since you know, our our focus of the podcast
is active management, and Bill alluded to it earlier, you know,
I just want to ask, especially for our listeners. You know,
why is active management required for this type of investment?
Speaker 4 (11:15):
You know, I think there's a few ways to answer that,
so so on. You really can't invest passively. I mean,
this is not a market where you can track an index, right,
I mean, just the way these dealers trade and the
way they're issued, it would be very difficult to have
a true passive product. But you know, I think we
we view it beyond that and really in terms of
(11:36):
the value that active management can provide in this asset class.
So it's really from two ways. I mean, one is
from a top down perspective, you know, in terms of
deciding how to position the portfolio. From a from a
risk perspective, so ratings, allocations or spread duration exposure, right,
(11:56):
you know, you you really do need to take a
macro view and and look at the current market and
your outlook and know when to maybe add risk, but
also when to d risk. And and I think also
becau understanding how different trenches are impacted by you know,
by the different types of investors in this market, I
(12:16):
think is also important. And you you you do need
an understand a deep understanding of the CLO market. And
I think it's actually quite unique from that perspective. Uh
So that's the top down part, but also from a
bottom up perspective, you know, you can't just invest based
on a rating. When you look at manager, vintage, underlying portfolio,
(12:38):
I mean, all of these will will impact the performance
of a clo and your d dispersion in performance even
among celos within the same rating category.
Speaker 3 (12:48):
So security selection can also be very additive.
Speaker 2 (12:52):
Yeah, so I wanted to come back to what the
Bible was talking about before regarding the investor base. So
we have the sort of the wealth clients, and we
have the insurance companies, and as you're pointing out, the
insurance companies already familiar with clos, so maybe from that
perspective they a bit less interesting here. But I think
the wealth clients might be quite interesting here because clearly
(13:16):
c ETFs have grown quite a bit, especially in the US.
They're starting to grow in Europe as well. And as
they grow and they become a larger part of the
investor base for clos, they will start to influence how
clos themselves are trading, and that means that all investors
in clos will have an interest in understanding how c
ETFs will influence the market and how these assets are
(13:40):
being traded, how their price, how liquid they are, how
stable the liquidy is as well, And so I was
wondering what is sort of the nature of these wealth investors.
Are they providing sticky money or is it more flighty money?
How exactly do you think they will start to affect
how etfclos will invest in the market, and that intourn
(14:03):
will affect the COLO market.
Speaker 5 (14:05):
We are seeing stickier allocations at the start here, and
one it's been a long call it sales cycle into
allocations from the wealth channel, because these guys and ladies
do their homework. They are not going to jump into
this asset clash just because it's now got about forty
(14:25):
billion in ETF flows.
Speaker 3 (14:28):
So there's a lot of education up front. Number one.
Speaker 5 (14:31):
Number two, the premise, particularly with the investment grade COLO allocations,
is that these do belong as part of a core
fix income allocation. They hadn't for most people in the
West channel because there was no access. So it's our
belief that in that channel people have bought in to
(14:55):
that concept. And there's plenty of history through lots of
market cycles. Remember, clos have been around since the nineteen nineties,
so there's lots of data and history to back up
the notion of sort of a core allocation. All that
being said, since colo ETFs have come into existence, although
we have seen pockets of volatility, we have not seen
(15:18):
a truly dramatic turn in a credit cycle. So there
will be some testing of you know, supply demand for
these vehicles, you know, when we really do and we
know it will happen at some point when it's difficult
to say. We think the performance of the asset class
through a more dramatic turn into credit cycle will again
(15:41):
the asset class will again I prove itself. But there probably,
you know, will be maybe some less committed investors who decide,
you know, perhaps at the wrong time, but you know,
we maybe that this isn't for them, So we'll see
how that goes. I just wanted to point out that
that hasn't fully occurred yet.
Speaker 1 (16:01):
If we get into the portfolio management aspect just a
little bit, how do you evaluate the underlying collateral? You
know what metrics attract.
Speaker 5 (16:09):
There's there's a lot of metrics that are tracked and
certainly you know, pine Bridge as a colo issuer themselves
as having a very very large leveraged finance group with
lots of individual credit analysts. You know, they have systems
built to do a very granular view of each clo,
(16:32):
which means looking at the loan level to assess risks
and then of course stress testing, uh, you know, with
sector disruptions, overall market disruptions, and they are monitoring making
sure there are already a lot of restrictions on clos
in order for these tranches to earn their ratings, so
(16:54):
enforced levels of diversification. A typical COLO these days is
going to have three to four hunds loans if not
more in the portfolio.
Speaker 3 (17:03):
You're not going to see.
Speaker 5 (17:06):
Individual issuers being representing more than one or two percent
of these portfolios, so they're already highly diversified. They have
to meet all sorts of coverage tests as well, but
you'll see a very very granular look. And I should
mention also, and Bill already did that the manager selection
is extremely important. I think there are more than one
(17:28):
hundred and fifty COLO managers in the US market alone
right now, and they are not all equally experienced or
equally capable, So that manager selection understanding the team, the experience,
the level of analysis they're doing, how they manage the portfolio.
(17:49):
Key critical component of colos in general is that they
themselves the collateral pools are actively managed. So those COLO
managers is not just important how they initially construct the CLO,
but how they manage it over time and whether or
not they act in the best interest of the debt
holders in various circumstances. So a lot of inputs, I
(18:12):
guess is a short answer to that question.
Speaker 1 (18:15):
So just a follow up, how do you decide between
investing in new issuance versus secondary market trongest.
Speaker 5 (18:24):
Yeah, there's a relative value sort of question there. Typically
you would expect to in most environments to gain some
additional spread by going into the new issue market, but
there can be even when that is the case, and
currently that is the case where the new issue market
(18:45):
is the relative value or the excess spread is narrowed
even in October with a little bit of volatility earlier
in the month, to where the primary market is not
absolutely the more active space to be, but still a
little bit of value there. But there are so many
other factors. For instance, pine Bridge, right now, we talked
(19:09):
about being conservatively positioned in this portfolio, when they are
looking for lower rated tranches or doing a bottom up
look to see if there's some value out there in
the market. Given the overall positioning, there's not a desire
to add long duration in the triple B part of
(19:31):
the portfolio right now, because that additional sensitivity to credit
spread movements, or that additional spread duration in those lower
rated tranches would lead to greater sensitivity should there be
a backup and spread. So it's in the secondary market
well seasoned tranches where you might be able to find
some attractively priced deals that also have a shorter duration,
(19:54):
so you're not as sensitive even when you're going down
the credit spectrum to gain some additional yield.
Speaker 2 (20:00):
Sticking with the secondary market, I was actually wondering, I mean,
we've had quite a bit of tariff turmal a few
months ago now, quite a few months ago now, but
I thought this was actually an interesting sort of test case,
and I'm just wondering, how do you think, as the
CELO investor, tariffs will affect the performance of the CEOs,
and how do you think your ETF investors think the
(20:25):
tariffs will affect the clos. It says there are difference
or are you sort of on the same page on this.
Speaker 5 (20:33):
I think there are as many opinions as there are
investors at this point because it's such a rapidly changing environment.
I think the generally accepted wisdom is really though, that
there is a level of uncertainty, and there is a
level of call it your credit, negative impact or impingement
(20:59):
on profitable in certain sectors. Who's paying How that all
plays out is still in I think most investors' minds
a bit to be determined. So the initial impact the
tariff tantrum that did create some interesting opportunities in the
(21:21):
market and was a small test, but really what we've
seen since then is more of a discounting of the
impact of tariffs because you know, there's certainly we think
there will be greater impact, and it will happen over time,
and some of it's been postponed by front loading inventories
(21:41):
or other measures, and simply you know, policies changing on
the fly and suspensions. But you know, generally speaking, it
will impact the market overall, should probably at some point
lead to wider spreads in some sectors. But I don't
think there's any conception answers and where that is, and
(22:02):
I think both investors and COLO managers and COLO trench
managers all all parties you'll share some form of those opinions,
or most of most parties in all three cohorts.
Speaker 2 (22:15):
Yeah, And I'm actually thinking maybe we are sort of
in a similar situation with the topic that we started
out with, which is what is going to happen to
interest rates and inflation? And we're to monetor policy in
the US more generally going forward, and I could imagine
that currently it's not quite clear how things will ultimately
pan out. Will the years really have a completely fiscally
(22:37):
dominated monetary policy, will it be somewhere in the middle,
will it go back to orthodox monetary policy? Do you
do you sense that there's a consensus amongst dicilar investors
or the ETF investors. Maybe not? And if there isn't,
is it something that people are nervous about or is
there not other're not too worried about it.
Speaker 5 (22:56):
There is in my mind, and they'll please disagree. As
you talk to a lot of other people as well,
there is no consensus. I think there's a perceived risk
of too much easing. Of course, there are people out
there who still argue that the FED has moved too slowly.
(23:16):
Is my personal opinion that to this point, with or
without the perceived interference from executive members of that branch,
the FED is probably where they would have been right
now without all the noise. So the question is more
about twenty twenty six. We think if left to their
(23:37):
own devices, the prospects for cuts in twenty twenty six
at this point, based on what we know, would probably
be pretty slim. So anyway, I think there's a level
of concern if I think if it were really priced in,
you would see some different market conditions, including a much
steeper yield curve. And we're just you know, although you
(24:00):
could say the curve is normalized, it's still not even
steep from historical point of view. It's sixty basis points
or so, say between two year and ten year treasuries
inside of long term average. And by the way, with
you agree with so much of what you're saying about
the risk to you know, physical dominance, a less independent
(24:21):
central bank, and you know, potential stagflation. One thing I
would say again, you know, highly rated clos would suffer
from lower coupons in that environment, not benefit you know
from you know, the short rates that should be rising,
and you know, everyone every corner of the income market
(24:44):
that would probably suffer from a negative real rate point
of view, But you definitely would not be wanting to
have long duration exposure in that type of environment either.
So that's like the cleanest, sturdy sh argument, where you know,
relatively speaking, you still might be better off at the
(25:05):
front end, but you know that that's just obviously not
a good environment for income allocations, at least heading into
it in general.
Speaker 2 (25:15):
Yeah, and you're bringing up ratings and hence credit risk,
and I think on that front, we obviously just had
first brands, and you know, it's still developing situations. Obviously
there are lots of accusations of fraud. I guess eventually
things will become clearer and we'll know what exactly happened.
(25:37):
But of course, what has happened in terms of the reaction,
maybe more in depressed than with investors, but maybe also
with investors, is that people have been starting to worry
a little bit that this might not be just it
using credit risk, even though it is fraud, and that
can often be using credit or if it is fraud,
it can often be using cretic but it might actually
(25:57):
be more systematic, or the idea is that, well, if
there's fraud here, if that's what happened, then maybe there's
that's that's more indicative of a problem across maybe private credit,
or maybe it's a problem across borrows that appear in
Coelo pools, and so it's a bigger concern than if
it was just a single name that was involved here.
(26:20):
And I guess that sort of narrative has gotten a
bit of an uplift from the fact that we have
seen in USABS another name that seems to have somewhat
similar problems, which is Tricolor, and so maybe that can
be used as some I think tootal evidence that maybe
there's more to destore than just a single name. We'll
eventually find out whether that's true or not. But currently,
(26:43):
how have the co Lo ETF investors been processing this information?
All of the news headlines about what has happened or
not happened at First Brands, about CLO's exposures to First
Brand and and what impact that might have CEOs, how
have they been trying to digest this information.
Speaker 4 (27:06):
Well, we've certainly gotten a few questions about, you know,
exposure to First brands, and I wouldn't say it's been
you know, overwhelming in terms or the investors seem overly concerned,
And I would say, you know, the nice thing about
Coelos is that there is transparency, so we can we
can certainly answer those questions. And you know, our our portfolios,
(27:29):
like you know, I think most clos have have pretty
very small exposure right to to these single names or
in this case, to first brands, So if you're in
the senior chanches, you know there's very little impact. But
but to your point, the bigger concern is whether these
are indications of something more systemic, and you know our
(27:52):
viewers that it's not. But we we've actually been saying
for quite some time that you know, we we do
it expect to see some distress among weaker credits in
the loan market. And the fact is that certainly not
every part of the economy is firing on all cylinders
(28:12):
and first brands, and try color show that even though
you know, these could be probably more a result of
mismanagement and potentially fraud.
Speaker 3 (28:24):
Rate cuts could.
Speaker 4 (28:25):
Take some pressure off some of these borrowers. But but
we don't expect to see a significant number of cuts
in and really any you know, impact of some slow
down in the economy is going to have an impact.
And in the meantime, of course, right these barbers do
need to refinance their loans. So from a COLO perspective,
you know, we don't view this as a systemic issue
(28:48):
at this point. We think fundamentals overall are you know,
remain strong. But you do really need to look under
the hood. And I think this is where you know,
security selection and credit analysis are really important, especially if
you're investing at lower rated tranches.
Speaker 1 (29:05):
Yeah, so just another you know, as we're talking about risks,
how is liquidity risk and clos assessed? And you know,
what is your view on the liquidity portfolio of these portfolios?
And you know, it's always a stressed market condition.
Speaker 5 (29:23):
When you're asking that question, you're asking more about the
clo etf So the liquidity in the tranches or the
liquidity in the clos themselves and the underlying collateral pools. Yeah, okay,
so and we could speak to both. I mean, obviously
the but the loan market itself, the leverage on the
(29:43):
market which makes up the pools. You're fairly look, of course,
liquidity drops off in times of stress, and the same
will tend to happen in the CLO trans space, but
it's always a matter of degree as you go down
the credit ratings ectrum. So we've seen, you know, since
we've launched COLI about three and a half years ago,
(30:08):
we've actually seen triple A tranches which this fund has
you know, maintained a decent sized position in among the
rest of them, some great trade b sort of liquidity
outlet even versus other types of fixing connollocations. Certainly that
happened with the British pension funds back in twenty twenty two,
(30:30):
where it was triple A clos became the liquidity tool
for them, So not without some price loss, but you know,
a couple of points versus multiple multiples of that you
might experience in other parts of the credit spectrum.
Speaker 3 (30:49):
As you go down the credit curve.
Speaker 5 (30:50):
Yeah, you're going to see wider spreads and greater wider
bit ass spreads, greater price losses. But it's really interesting
in the COLO market to remember number one, the triple
A tranches over sixty percent of the market, so you
already have you know, smaller markets in all of the
other tranches, but those as you go down the the
(31:14):
b wick volume that bid wanted in competition, or the
amount of trading that goes on as a percentage of
the amount outstanding goes up the further you go down
the credit spectrum. So those markets do tend to clear
through periods of stress, but not without higher transaction costs.
(31:34):
If it's you know, the going down to the double b's,
which might you know, the bottom rung of what's in
our colo b ETF you might see you have point
to a point bid asked in normal times, and that
could widen out, you know, significantly in other periods, which
is again why effrective management in this.
Speaker 3 (31:55):
Area is super super important.
Speaker 5 (31:57):
That's also why when we wanted to approach the mezzanine
part of the capital stack, we wanted to include double
a's and single as to have those more liquid trudges.
Single a's obviously you're not going to be like triple b's,
but double a's are not far off in terms of
maintaining a high degreeclid in the stress periods, at least historically.
Speaker 2 (32:23):
Yeah, and speaking of historically, I mean we I can't
help but notice that we very much in the tail
end of the year now and so now your thoughts
turned to twenty twenty six, and in that context, I've
sort thought about what might happen with the silo market
and cotfs next year. And when you two things to
(32:43):
note right, One is they have grown a lot become
a more important part of the investor base, and we
have actually seen an extreme version of that with the
cilos themselves. They're now one of the most important, is
not the most important investor in the underlying levish loan market.
And the question, Denny, is do we think that something
similar like that might actually start to happen in the
(33:06):
COLO market as well? Will ETF funds become so dominant
that they become the dominant investor in the acid class?
Speaker 3 (33:13):
So our view is that, you know, we don't.
Speaker 4 (33:15):
We don't expect that ETF will become the dominant investor
in in the COLO market. There's obviously a lot of
other types of UH institutional investors that have a very
large presence, and we don't see that changing. And I,
you know, I think it's important to note that ETFs
have they have grown a lot in the last few years,
but it's still a small part of the overall market.
(33:39):
That being said, I mean, they as they do grow
and we maybe we're already seeing some of this, there
can be impacts at the margins, right when you consider
that historically a lot of the COLO investors were more
buy and hold. Now you have.
Speaker 3 (33:56):
ETFs, which at least you know, have the ability.
Speaker 4 (33:59):
To have daily inflows and outflows, and that can certainly
have an impact. And you might have investors with different
that that react differently right to different events. So, you know,
looking thinking back to a year ago, at the end
of last year and into this year, we saw very
(34:20):
strong and accelerating inflows into into cl O E t
S and I would say the majority of that was
going into two triple a's and we we did start
to see you know that triple A spreaders.
Speaker 3 (34:35):
Just looked really tight. We didn't see value there.
Speaker 4 (34:39):
Now that's not to say that this is all because
of col O ETFs, but I think it's also interesting
to look at April when we that was that was
really the first short tests that we have seen for
cl O E t F since they launched, where we
did see some redemptions and they weren't insignificant. I mean,
(34:59):
it was small relat to AUM, but we did see
redemptions across most of the colts and and actually saw
some uh, you know, some of the widening we saw
interpol As was maybe a little more than you might expect.
And again it's hard to attribute that necessarily to co
O ETFs, but you know, I think the point is
(35:19):
that you do have now buying and selling from a
new type of investor in the SELO market, and that
can have an impact that the margins. I don't think
it's driving the market, but it can have can maybe
exaggerate some of the market moves in some parts of
the market, you know, and for us that that could
(35:41):
out influence our allocation because we are looking to see
where there's value, So that type of behavior can can
certainly impact our how.
Speaker 3 (35:51):
How we are invested in.
Speaker 5 (35:53):
There's another interesting aspect of this as well, which is
if you want to draw a parallel with high you
bonds different a different market. But as the ETFs grew
and people became concerned about their impact in daily liquidity
vehicles on the overall market, what you tend to see
(36:13):
in times of stress, once those funds hit critical mass
is much of the volume trading volumes would go up
in ETFs. They would go down in the cash market
due to a drop off from liquidity and a stress market.
The percentage of primary market activity i e. Redemptions and
(36:33):
creations as a percentage of volume in those ETFs also plummeted,
which means the ETF market makers were managing and laying
off their risk in the secondary market for those shares.
So in a way, the price movements might have been
contributing or advertising the volatility in the market, but there
(36:54):
wasn't the degree of force selling that people might have
either feared or wished for or imagined. Because the critical
mass had been achieved and the secondary market trading became
a great way to manage risk in an aspirational sense,
that's what we were hoping for the COLO universe.
Speaker 3 (37:16):
We think to some degree that did occur in April.
Speaker 5 (37:20):
The market now has recovered and grown more since then,
and we think, you know, there's a possibility that that
type of evolution continues.
Speaker 2 (37:31):
Yeah, And actually you mentioned evolution, and I think a
previously early to differentiation. I was also thinking, so now
that we have a dismal mass of co ETFs, I
would have thought the various managers are going to start
to think more about how to differentiate themselves and in
the process there might be more of a product differentiation
(37:52):
as well. So clearly BSL clos are the dominant type
of cilo still and my guess is a large part
of the investments made by clotfs go into BSL clos.
But we also have other cls nowadays. So we have
mid market clos that have been around for quite a bit,
then quite large now and more recently we've seen sire
(38:14):
commercial real estate clos appear on the scene. And of
course a lot of people have been talking about private
credit clos, some wondering and I really been maybe looking
a fair few years ahead now, not just to twenty
twenty six, but a bit further. Is there a prospect
that the clotf market will start to offer a broader
(38:37):
range of ETFs where some focus more on BSL clos,
some focus more on mid market, some might be focusing
for more on CER clos, some might be more dynamically
allocating between the various types of clos. How do you
see that developing?
Speaker 4 (38:56):
I think that's definitely, you know, I think I definitely
expect to see continued product development in this space. That
you know, anytime you have strong inflows. It does attract
new ideas, I guess I would say, and as you said,
we're seeing middle market private credit celos being put into ETF.
I think there's even a leveraged l O ATF now,
(39:21):
and you know people are looking at it, not directly related,
but you know, private true direct lending now in ETFs. Ultimately,
I think the market, of course will determine whether there's
demand for these products, and especially as you get more
niche I think, you know, they really need to have
(39:42):
a compelling value proposition within a portfolio. But I guess
I would also say, you know, you know, we've talked
about liquidity a few times today and in the product
development process, I mean, we view a liquidity assessment as
really a crucial part of that, really like the initial
part of any product development or any idea. When you're
(40:05):
talking about et s, right, ets have daily inflows and outflows.
They trade through the day, so you need pricing trans fancy.
So you really do need a large and liquid underlying
market because otherwise you can run into issues. And I
think you know it's fans had a lot of uh,
the products, some of these especially some of these more
(40:26):
you know, let's call them. Innovative products that have launched
in recent years haven't really been through any tests, whether
you know, some market event like a big credit shock
or a liquidity event, and you just really don't want
to be in a scenario where you have trouble to
satisfy redemptions or you're you find yourself selling assets at
(40:49):
fire cell prices. So you know, the way we chose
to differentiate was going beyond triple A, right, but still
saying within b SL clos and just taking a broader approach.
And you know, our products were designed to be more
of a strategic holding in a portfolio. So accordingly, we
looked at you know, making sure that the underlying market
(41:12):
was large and liquid and really and set the right
guardrails really to to to manage liquidity risk.
Speaker 1 (41:22):
So this could be for either one of you. But
what do you consider the key headwinds and tailwinds for
the cl market, both investment grade and non investment grade
over the next you know, say, twelve to twenty four months.
Speaker 5 (41:36):
Stark in reverse sort of the tailwinds. We're still in
a the nine credit environment. You still got base rates
that are just below four percent, so you've got solid
credit underpinning still an attractive spread over you know, a moderate,
modestly attractive base rate. That's still a positive rate by
(42:00):
a decent clip. So you know, those are those are
the tailwinds that even if people are worried about the
first headwind I'll mention, which is simply you know, more
rate cuts would tend to lower the coupons unless the
credit spreads widened out to compensate for that. So, uh,
you know, we still think there's a relative attractiveness to
(42:23):
clos that is going to continue into twenty twenty six.
Even if we see you know, another recut in December
and one or two over the course of the next
year to rate those points earlier. If there's more than
that next year, that may change some of the dynamics,
But for now we see that combinations as still you know,
(42:44):
a good, good tailwind for the COLO space. Potential headwinds
Aside from that, you know, overly aggressive FED cutting is
more just macro. Right. If if we see a turn
driven by you know, a couple of the key concerns
we've seen out there, the labor market, uh, you know,
(43:04):
well the consumer in the US finally show some weakness
that starts impacting various sectors of the economy.
Speaker 3 (43:13):
Will tariffs have you know.
Speaker 5 (43:16):
An outsize impact that people seem to be as we
talked about earlier, maybe discounting some of that impact. Now,
is there been a delayed effect and will that come
to rusful geopolitics, anything that could upset this benign credit story.
But when you look at earnings and you know, leverage ratios,
even in the risky credit space, even the fault rates
(43:36):
which had ticked up, but we're still somewhat modest and
certainly manageable within the COO context.
Speaker 3 (43:43):
Uh, you know that that hasn't been the case yet.
Speaker 1 (43:48):
Well, unfortunately we need to end here. But this was
a fantastic conversation. I really thank both of you for
joining us today.
Speaker 3 (43:55):
Thanks very much joining us. Really enjoyed it. Yeah, this
was a lot of fun. Thank you guys and Retto.
Speaker 1 (44:00):
I'd like to thank you for being my co host today.
Speaker 2 (44:02):
No worries at all, what's my pasure and.
Speaker 1 (44:04):
I want to thank you for listening. If you liked
the episode, please subscribe and leave a review. Also, if
you'd like to see more of our research on the terminal,
please go to bi fund Go for fund research and
bi st r t n GO for credit research until
our next episode. This is David Cohne with Inside Active
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges, and philosophies and security selection. I'm David Cohne,
i lead mutual fund and active Research at Bloomberg Intelligence.
Today my coast is Rehdel Bachmann, Chief structured finance strategist
at Bloomberg Intelligence RADDA. Thank you for joining me as
(00:34):
my coast today.
Speaker 2 (00:35):
Oh, it's my pleasure.
Speaker 1 (00:37):
So since our discussion today is going to be on CLOS,
I did want to ask about a note you put
out recently about USCLO structural performance. Can you give our
listeners a brief overview of how current fiscal policy could
affect CLO returns?
Speaker 2 (00:53):
Yes, So that was something I wanted to alert CLO
investors too, because it's something it's a kind of risk
that they might not be used to. In the West.
Have been used to central banks running orthodox monetary policies,
which means that they're very much focused on price stability.
They may have other objectives as well, but price to
bility is certainly a key one, and as a result
of that, what we expect to happen when inflation goes
(01:14):
up is that policy rates also go up, and vice versa.
So our presumption tends to be that foreign nodes, including
ef ends, including clos are effectively sort of inflation hedged.
When inflation goes up, yes, the principle becomes less valuable
in real terms, but as policy goes up, floating rates
(01:36):
go up, and as a result, coupons go up, and
then the higher couponts compensate for the loss of the
real value in the principle. So that's how we used
to think about it. Of course, if you're an emerging
markets investor, then you're used to different types of monetary policies,
especially physically dominated monetary policies. These are situations where the
government is really dictating monetary monetary policy, usually with a
(01:59):
view to enabling the funding of the state. And so
what happens under these regimes often is that inflation is higher,
but despite that, interest rates are lower than there would
be under orthodox minetary policy, and all of a sudden,
when that happens, and when you're under that regime, then
the clos are no longer effective for inflation headed because
(02:20):
what happens is that inflation goes up the floating rates
don't go up, so the coupons don't go up, and
as a result of that, you don't get compensated for
the loss in the real value of the principle. And
of course, currently we have the situation in the US
where there's a wankling over ultimately what the monetary policy
should be. The FED, at least so far, seems to
be more leaning towards the orthodox minetary policy to some extent,
(02:44):
and of course the administration would like to have a
monetary policy that's more focused on funding the state, lower
interest rates and higher inflation. And so this is going
to change, especially if we do end up in a
situation where we have a fully physically dominated monetary policy
in the US. Yes, that's going to change the risk
return trade for clos, and then there's a discussion about
(03:05):
how exactly that would affect clos. The collateral performance will
will be good because the borrowers in the colateral pull
on the same situation as the state. They benefit from
an erosion of the real value of the principle that
they owe, and they benefit from having to pay low
interest rates because the loans are also floaters. And of
course from a structural perspective, the CELO wouldn't be much
impact it because the structure itself doesn't have interested exposure
(03:28):
because both the liabilities and the assets of floaters. But
for the COLO investors, the brisk returns of period of
are very different under fiscal dominance than they are on
the orthodox minitary policy.
Speaker 3 (03:40):
Yeah.
Speaker 1 (03:40):
Interesting, Well, I'm sure our guests today could also provide
some color into that. So out further ado, I'd like
to welcome friend Rodoloso and Bill so calls Inside Active.
Bill is director of product Management at VNAC, and Fran
is head of Fixed Income ETF portfolio Management at VNACK
and a portfolio manager on the VNAC CLO ETF and
(04:01):
the AA B B c l O ETF ticker c
l O I in c l O B. Brandon, Bill,
thank you so much for joining us today.
Speaker 3 (04:10):
It's great to be here. Thanks David, thanks for having us.
Speaker 1 (04:13):
To get started. I'll go first to you. Bill. Can
you walk us through the main investment thesis for CLO
I in cl O B.
Speaker 3 (04:21):
Yeah, of course.
Speaker 4 (04:22):
So, you know, I think for both funds the thesis
is really that CLOS can help build a stronger bond portfolio.
And that all investors should have access to clos and
of course that wasn't really the case until we started
seeing these ETFs launch, But so that that's one aspect
of the other is that, you know, we believe you
(04:43):
can achieve better outcomes by not constraining yourself to a
single rating category, and that you really do need to
take an active approach in this market. So as far
as you know, the constraining yourself to a single rating category,
you know, if you look at the the COLO market
today and historically it's been dominated by institutional investors and
(05:06):
they do tend to focus on single ratings. So banks
are the biggest investors in clos and certainly the biggest
in triple a's, and you're not really going to see
them going to mezzanine tranches. And the reason is that
they're highly regulated, they have regulatory capital constraints, and really
only triple as makes sense for them. But when when
(05:28):
we were thinking about launching our funds, you know, we
took the approach that you know, most investors don't have
these constraints and you can get more income and find
additional opportunities if you can take advantage of the whole
capital structure. So both of our ETFs are based on
this idea that you know, if you can invest broadly
(05:48):
and take advantage of that capital structure that the CLO has.
Speaker 3 (05:52):
You can you can have better outcomes.
Speaker 4 (05:54):
And uh col I focuses on investment grade tranches and
we think that it's a useful strategy within a broader
core bond portfolio, and we also offer COLOB which focuses
on mezzanine tranches, so primarily double A to double B.
So it's, you know, it's a higher returning potential but
(06:16):
also higher risk strategy that we think can be a
good compliment a high yield.
Speaker 1 (06:22):
So you mentioned, you know, it's typically institutional investors that
have had access to these Who's the target investor for
these to ETFs? Is it you know everyone or are
you kind of looking to get more of retail investors involved.
Speaker 4 (06:36):
Well, you know, I'd say there's not necessarily one type
of target investor necessarily, and I think that's one great
thing about the ETF is that all types of investors
can can buy it and have the same exposure at
the same cost.
Speaker 3 (06:52):
You know.
Speaker 4 (06:52):
That being said, in our funds, we've primarily seen interests
and aum come from the wealth channel, so this is
this is r as SO registered investment advisors and also
advisors that you know, broker dealers, including some of the
big wirehouses that you know that everyone knows. And these
(07:13):
of course are investors who haven't really had access to
celos before these etf started launching, certainly not in a
liquid vehicle. So so for many of these investors it's
the first time they're they're learning about celos and and
have the opportunity to add them into their portfolio. UH.
(07:33):
We have also seen a pretty sizable interest from institutional
investors as well in RTF and primarily that's the insurance market,
so insurance general accounts, and unlike the wealth channel, you know,
for many of these insurance companies, celos are not new.
These are insurance companies in general are big investors in
(07:53):
celos and and often they they may have invested directly
with COLO tranch manager, but with ETFs, you know, in
smaller portfolios or with smaller insurance companies, you know, an
allocation to a separate account with a CLO tranch manager.
(08:14):
UH maybe was too large for some of these smaller portfolios.
So the ETFs are are great to get that exposure.
I think we're also seeing the ETFp used as part
of a broader COLO allocation. So sometimes these general accounts
are buying clos directly or or maybe through a separate account,
(08:36):
but they're using the ETF alongside those holdings as a
liquidity sleeve. So so it's a way to optimize liquidity.
Speaker 2 (08:43):
Yeah.
Speaker 1 (08:44):
Now my next question could be for either one of you,
how do you define the market opportunity for CLO tranches today?
Speaker 5 (08:53):
They'll do I'm gonna lead off. I'll say say this,
there's a relative value opportunity to begin with. So if
you compare the higher rated tranches versus other forms of abs,
you know, the CLO tranches are going to offer a
more attractive spread than almost all the other alternatives, and
(09:14):
certainly versus investment grade corporates at any step along the
rating scale, a meaningful pickup in yield. So just in
general from an allocation perspective, of course, with the floating
rate nature, you can add yield and reduce duration in
your portfolio, you know, thereby reducing one form of risk.
(09:37):
So we think with you know, investment grade clos, there's
this opportunity to really add some kind of permanent allocation
to enhance overall, you know, your sharp ratio basically, you know,
in terms of today sort of bottom up opportunities or
relative value within.
Speaker 3 (09:57):
The CLO market.
Speaker 5 (10:00):
Certainly, spreads have compressed in every corner of the credit
market in general. And although COLO spreads are wide on
a relative versus other asset classes, it's not a time
we believe, Nor by the way we work with the
subadvisor on these funds, Pine Bridge, who's got very deep
experience in this space, we're both in agreement this is
(10:23):
not a time to go too far down the credit
spectrum in order to add yield, So a more conservative
approach is warranted. But there are plenty of bottom up opportunities.
You can still find value in the secondary market and
some of the lower rated tranches, more so in the
(10:44):
primary market, where the spreads are still slightly more attractive
in the higher rated tranches. But that type of positioning
right now should still provide an attractive yield to investors
versus most other alternatives in the income space.
Speaker 3 (11:01):
Yeah.
Speaker 1 (11:02):
And since you know, our our focus of the podcast
is active management, and Bill alluded to it earlier, you know,
I just want to ask, especially for our listeners. You know,
why is active management required for this type of investment?
Speaker 4 (11:15):
You know, I think there's a few ways to answer that,
so so on. You really can't invest passively. I mean,
this is not a market where you can track an index, right,
I mean, just the way these dealers trade and the
way they're issued, it would be very difficult to have
a true passive product. But you know, I think we
we view it beyond that and really in terms of
(11:36):
the value that active management can provide in this asset class.
So it's really from two ways. I mean, one is
from a top down perspective, you know, in terms of
deciding how to position the portfolio. From a from a
risk perspective, so ratings, allocations or spread duration exposure, right,
(11:56):
you know, you you really do need to take a
macro view and and look at the current market and
your outlook and know when to maybe add risk, but
also when to d risk. And and I think also
becau understanding how different trenches are impacted by you know,
by the different types of investors in this market, I
(12:16):
think is also important. And you you you do need
an understand a deep understanding of the CLO market. And
I think it's actually quite unique from that perspective. Uh
So that's the top down part, but also from a
bottom up perspective, you know, you can't just invest based
on a rating. When you look at manager, vintage, underlying portfolio,
(12:38):
I mean, all of these will will impact the performance
of a clo and your d dispersion in performance even
among celos within the same rating category.
Speaker 3 (12:48):
So security selection can also be very additive.
Speaker 2 (12:52):
Yeah, so I wanted to come back to what the
Bible was talking about before regarding the investor base. So
we have the sort of the wealth clients, and we
have the insurance companies, and as you're pointing out, the
insurance companies already familiar with clos, so maybe from that
perspective they a bit less interesting here. But I think
the wealth clients might be quite interesting here because clearly
(13:16):
c ETFs have grown quite a bit, especially in the US.
They're starting to grow in Europe as well. And as
they grow and they become a larger part of the
investor base for clos, they will start to influence how
clos themselves are trading, and that means that all investors
in clos will have an interest in understanding how c
ETFs will influence the market and how these assets are
(13:40):
being traded, how their price, how liquid they are, how
stable the liquidy is as well, And so I was
wondering what is sort of the nature of these wealth investors.
Are they providing sticky money or is it more flighty money?
How exactly do you think they will start to affect
how etfclos will invest in the market, and that intourn
(14:03):
will affect the COLO market.
Speaker 5 (14:05):
We are seeing stickier allocations at the start here, and
one it's been a long call it sales cycle into
allocations from the wealth channel, because these guys and ladies
do their homework. They are not going to jump into
this asset clash just because it's now got about forty
(14:25):
billion in ETF flows.
Speaker 3 (14:28):
So there's a lot of education up front. Number one.
Speaker 5 (14:31):
Number two, the premise, particularly with the investment grade COLO allocations,
is that these do belong as part of a core
fix income allocation. They hadn't for most people in the
West channel because there was no access. So it's our
belief that in that channel people have bought in to
(14:55):
that concept. And there's plenty of history through lots of
market cycles. Remember, clos have been around since the nineteen nineties,
so there's lots of data and history to back up
the notion of sort of a core allocation. All that
being said, since colo ETFs have come into existence, although
we have seen pockets of volatility, we have not seen
(15:18):
a truly dramatic turn in a credit cycle. So there
will be some testing of you know, supply demand for
these vehicles, you know, when we really do and we
know it will happen at some point when it's difficult
to say. We think the performance of the asset class
through a more dramatic turn into credit cycle will again
(15:41):
the asset class will again I prove itself. But there probably,
you know, will be maybe some less committed investors who decide,
you know, perhaps at the wrong time, but you know,
we maybe that this isn't for them, So we'll see
how that goes. I just wanted to point out that
that hasn't fully occurred yet.
Speaker 1 (16:01):
If we get into the portfolio management aspect just a
little bit, how do you evaluate the underlying collateral? You
know what metrics attract.
Speaker 5 (16:09):
There's there's a lot of metrics that are tracked and
certainly you know, pine Bridge as a colo issuer themselves
as having a very very large leveraged finance group with
lots of individual credit analysts. You know, they have systems
built to do a very granular view of each clo,
(16:32):
which means looking at the loan level to assess risks
and then of course stress testing, uh, you know, with
sector disruptions, overall market disruptions, and they are monitoring making
sure there are already a lot of restrictions on clos
in order for these tranches to earn their ratings, so
(16:54):
enforced levels of diversification. A typical COLO these days is
going to have three to four hunds loans if not
more in the portfolio.
Speaker 3 (17:03):
You're not going to see.
Speaker 5 (17:06):
Individual issuers being representing more than one or two percent
of these portfolios, so they're already highly diversified. They have
to meet all sorts of coverage tests as well, but
you'll see a very very granular look. And I should
mention also, and Bill already did that the manager selection
is extremely important. I think there are more than one
(17:28):
hundred and fifty COLO managers in the US market alone
right now, and they are not all equally experienced or
equally capable, So that manager selection understanding the team, the experience,
the level of analysis they're doing, how they manage the portfolio.
(17:49):
Key critical component of colos in general is that they
themselves the collateral pools are actively managed. So those COLO
managers is not just important how they initially construct the CLO,
but how they manage it over time and whether or
not they act in the best interest of the debt
holders in various circumstances. So a lot of inputs, I
(18:12):
guess is a short answer to that question.
Speaker 1 (18:15):
So just a follow up, how do you decide between
investing in new issuance versus secondary market trongest.
Speaker 5 (18:24):
Yeah, there's a relative value sort of question there. Typically
you would expect to in most environments to gain some
additional spread by going into the new issue market, but
there can be even when that is the case, and
currently that is the case where the new issue market
(18:45):
is the relative value or the excess spread is narrowed
even in October with a little bit of volatility earlier
in the month, to where the primary market is not
absolutely the more active space to be, but still a
little bit of value there. But there are so many
other factors. For instance, pine Bridge, right now, we talked
(19:09):
about being conservatively positioned in this portfolio, when they are
looking for lower rated tranches or doing a bottom up
look to see if there's some value out there in
the market. Given the overall positioning, there's not a desire
to add long duration in the triple B part of
(19:31):
the portfolio right now, because that additional sensitivity to credit
spread movements, or that additional spread duration in those lower
rated tranches would lead to greater sensitivity should there be
a backup and spread. So it's in the secondary market
well seasoned tranches where you might be able to find
some attractively priced deals that also have a shorter duration,
(19:54):
so you're not as sensitive even when you're going down
the credit spectrum to gain some additional yield.
Speaker 2 (20:00):
Sticking with the secondary market, I was actually wondering, I mean,
we've had quite a bit of tariff turmal a few
months ago now, quite a few months ago now, but
I thought this was actually an interesting sort of test case,
and I'm just wondering, how do you think, as the
CELO investor, tariffs will affect the performance of the CEOs,
and how do you think your ETF investors think the
(20:25):
tariffs will affect the clos. It says there are difference
or are you sort of on the same page on this.
Speaker 5 (20:33):
I think there are as many opinions as there are
investors at this point because it's such a rapidly changing environment.
I think the generally accepted wisdom is really though, that
there is a level of uncertainty, and there is a
level of call it your credit, negative impact or impingement
(20:59):
on profitable in certain sectors. Who's paying How that all
plays out is still in I think most investors' minds
a bit to be determined. So the initial impact the
tariff tantrum that did create some interesting opportunities in the
(21:21):
market and was a small test, but really what we've
seen since then is more of a discounting of the
impact of tariffs because you know, there's certainly we think
there will be greater impact, and it will happen over time,
and some of it's been postponed by front loading inventories
(21:41):
or other measures, and simply you know, policies changing on
the fly and suspensions. But you know, generally speaking, it
will impact the market overall, should probably at some point
lead to wider spreads in some sectors. But I don't
think there's any conception answers and where that is, and
(22:02):
I think both investors and COLO managers and COLO trench
managers all all parties you'll share some form of those opinions,
or most of most parties in all three cohorts.
Speaker 2 (22:15):
Yeah, And I'm actually thinking maybe we are sort of
in a similar situation with the topic that we started
out with, which is what is going to happen to
interest rates and inflation? And we're to monetor policy in
the US more generally going forward, and I could imagine
that currently it's not quite clear how things will ultimately
pan out. Will the years really have a completely fiscally
(22:37):
dominated monetary policy, will it be somewhere in the middle,
will it go back to orthodox monetary policy? Do you
do you sense that there's a consensus amongst dicilar investors
or the ETF investors. Maybe not? And if there isn't,
is it something that people are nervous about or is
there not other're not too worried about it.
Speaker 5 (22:56):
There is in my mind, and they'll please disagree. As
you talk to a lot of other people as well,
there is no consensus. I think there's a perceived risk
of too much easing. Of course, there are people out
there who still argue that the FED has moved too slowly.
(23:16):
Is my personal opinion that to this point, with or
without the perceived interference from executive members of that branch,
the FED is probably where they would have been right
now without all the noise. So the question is more
about twenty twenty six. We think if left to their
(23:37):
own devices, the prospects for cuts in twenty twenty six
at this point, based on what we know, would probably
be pretty slim. So anyway, I think there's a level
of concern if I think if it were really priced in,
you would see some different market conditions, including a much
steeper yield curve. And we're just you know, although you
(24:00):
could say the curve is normalized, it's still not even
steep from historical point of view. It's sixty basis points
or so, say between two year and ten year treasuries
inside of long term average. And by the way, with
you agree with so much of what you're saying about
the risk to you know, physical dominance, a less independent
(24:21):
central bank, and you know, potential stagflation. One thing I
would say again, you know, highly rated clos would suffer
from lower coupons in that environment, not benefit you know
from you know, the short rates that should be rising,
and you know, everyone every corner of the income market
(24:44):
that would probably suffer from a negative real rate point
of view, But you definitely would not be wanting to
have long duration exposure in that type of environment either.
So that's like the cleanest, sturdy sh argument, where you know,
relatively speaking, you still might be better off at the
(25:05):
front end, but you know that that's just obviously not
a good environment for income allocations, at least heading into
it in general.
Speaker 2 (25:15):
Yeah, and you're bringing up ratings and hence credit risk,
and I think on that front, we obviously just had
first brands, and you know, it's still developing situations. Obviously
there are lots of accusations of fraud. I guess eventually
things will become clearer and we'll know what exactly happened.
(25:37):
But of course, what has happened in terms of the reaction,
maybe more in depressed than with investors, but maybe also
with investors, is that people have been starting to worry
a little bit that this might not be just it
using credit risk, even though it is fraud, and that
can often be using credit or if it is fraud,
it can often be using cretic but it might actually
(25:57):
be more systematic, or the idea is that, well, if
there's fraud here, if that's what happened, then maybe there's
that's that's more indicative of a problem across maybe private credit,
or maybe it's a problem across borrows that appear in
Coelo pools, and so it's a bigger concern than if
it was just a single name that was involved here.
(26:20):
And I guess that sort of narrative has gotten a
bit of an uplift from the fact that we have
seen in USABS another name that seems to have somewhat
similar problems, which is Tricolor, and so maybe that can
be used as some I think tootal evidence that maybe
there's more to destore than just a single name. We'll
eventually find out whether that's true or not. But currently,
(26:43):
how have the co Lo ETF investors been processing this information?
All of the news headlines about what has happened or
not happened at First Brands, about CLO's exposures to First
Brand and and what impact that might have CEOs, how
have they been trying to digest this information.
Speaker 4 (27:06):
Well, we've certainly gotten a few questions about, you know,
exposure to First brands, and I wouldn't say it's been
you know, overwhelming in terms or the investors seem overly concerned,
And I would say, you know, the nice thing about
Coelos is that there is transparency, so we can we
can certainly answer those questions. And you know, our our portfolios,
(27:29):
like you know, I think most clos have have pretty
very small exposure right to to these single names or
in this case, to first brands, So if you're in
the senior chanches, you know there's very little impact. But
but to your point, the bigger concern is whether these
are indications of something more systemic, and you know our
(27:52):
viewers that it's not. But we we've actually been saying
for quite some time that you know, we we do
it expect to see some distress among weaker credits in
the loan market. And the fact is that certainly not
every part of the economy is firing on all cylinders
(28:12):
and first brands, and try color show that even though
you know, these could be probably more a result of
mismanagement and potentially fraud.
Speaker 3 (28:24):
Rate cuts could.
Speaker 4 (28:25):
Take some pressure off some of these borrowers. But but
we don't expect to see a significant number of cuts
in and really any you know, impact of some slow
down in the economy is going to have an impact.
And in the meantime, of course, right these barbers do
need to refinance their loans. So from a COLO perspective,
you know, we don't view this as a systemic issue
(28:48):
at this point. We think fundamentals overall are you know,
remain strong. But you do really need to look under
the hood. And I think this is where you know,
security selection and credit analysis are really important, especially if
you're investing at lower rated tranches.
Speaker 1 (29:05):
Yeah, so just another you know, as we're talking about risks,
how is liquidity risk and clos assessed? And you know,
what is your view on the liquidity portfolio of these portfolios?
And you know, it's always a stressed market condition.
Speaker 5 (29:23):
When you're asking that question, you're asking more about the
clo etf So the liquidity in the tranches or the
liquidity in the clos themselves and the underlying collateral pools. Yeah, okay,
so and we could speak to both. I mean, obviously
the but the loan market itself, the leverage on the
(29:43):
market which makes up the pools. You're fairly look, of course,
liquidity drops off in times of stress, and the same
will tend to happen in the CLO trans space, but
it's always a matter of degree as you go down
the credit ratings ectrum. So we've seen, you know, since
we've launched COLI about three and a half years ago,
(30:08):
we've actually seen triple A tranches which this fund has
you know, maintained a decent sized position in among the
rest of them, some great trade b sort of liquidity
outlet even versus other types of fixing connollocations. Certainly that
happened with the British pension funds back in twenty twenty two,
(30:30):
where it was triple A clos became the liquidity tool
for them, So not without some price loss, but you know,
a couple of points versus multiple multiples of that you
might experience in other parts of the credit spectrum.
Speaker 3 (30:49):
As you go down the credit curve.
Speaker 5 (30:50):
Yeah, you're going to see wider spreads and greater wider
bit ass spreads, greater price losses. But it's really interesting
in the COLO market to remember number one, the triple
A tranches over sixty percent of the market, so you
already have you know, smaller markets in all of the
other tranches, but those as you go down the the
(31:14):
b wick volume that bid wanted in competition, or the
amount of trading that goes on as a percentage of
the amount outstanding goes up the further you go down
the credit spectrum. So those markets do tend to clear
through periods of stress, but not without higher transaction costs.
(31:34):
If it's you know, the going down to the double b's,
which might you know, the bottom rung of what's in
our colo b ETF you might see you have point
to a point bid asked in normal times, and that
could widen out, you know, significantly in other periods, which
is again why effrective management in this.
Speaker 3 (31:55):
Area is super super important.
Speaker 5 (31:57):
That's also why when we wanted to approach the mezzanine
part of the capital stack, we wanted to include double
a's and single as to have those more liquid trudges.
Single a's obviously you're not going to be like triple b's,
but double a's are not far off in terms of
maintaining a high degreeclid in the stress periods, at least historically.
Speaker 2 (32:23):
Yeah, and speaking of historically, I mean we I can't
help but notice that we very much in the tail
end of the year now and so now your thoughts
turned to twenty twenty six, and in that context, I've
sort thought about what might happen with the silo market
and cotfs next year. And when you two things to
(32:43):
note right, One is they have grown a lot become
a more important part of the investor base, and we
have actually seen an extreme version of that with the
cilos themselves. They're now one of the most important, is
not the most important investor in the underlying levish loan market.
And the question, Denny, is do we think that something
similar like that might actually start to happen in the
(33:06):
COLO market as well? Will ETF funds become so dominant
that they become the dominant investor in the acid class?
Speaker 3 (33:13):
So our view is that, you know, we don't.
Speaker 4 (33:15):
We don't expect that ETF will become the dominant investor
in in the COLO market. There's obviously a lot of
other types of UH institutional investors that have a very
large presence, and we don't see that changing. And I,
you know, I think it's important to note that ETFs
have they have grown a lot in the last few years,
but it's still a small part of the overall market.
(33:39):
That being said, I mean, they as they do grow
and we maybe we're already seeing some of this, there
can be impacts at the margins, right when you consider
that historically a lot of the COLO investors were more
buy and hold. Now you have.
Speaker 3 (33:56):
ETFs, which at least you know, have the ability.
Speaker 4 (33:59):
To have daily inflows and outflows, and that can certainly
have an impact. And you might have investors with different
that that react differently right to different events. So, you know,
looking thinking back to a year ago, at the end
of last year and into this year, we saw very
(34:20):
strong and accelerating inflows into into cl O E t
S and I would say the majority of that was
going into two triple a's and we we did start
to see you know that triple A spreaders.
Speaker 3 (34:35):
Just looked really tight. We didn't see value there.
Speaker 4 (34:39):
Now that's not to say that this is all because
of col O ETFs, but I think it's also interesting
to look at April when we that was that was
really the first short tests that we have seen for
cl O E t F since they launched, where we
did see some redemptions and they weren't insignificant. I mean,
(34:59):
it was small relat to AUM, but we did see
redemptions across most of the colts and and actually saw
some uh, you know, some of the widening we saw
interpol As was maybe a little more than you might expect.
And again it's hard to attribute that necessarily to co
O ETFs, but you know, I think the point is
(35:19):
that you do have now buying and selling from a
new type of investor in the SELO market, and that
can have an impact that the margins. I don't think
it's driving the market, but it can have can maybe
exaggerate some of the market moves in some parts of
the market, you know, and for us that that could
(35:41):
out influence our allocation because we are looking to see
where there's value, So that type of behavior can can
certainly impact our how.
Speaker 3 (35:51):
How we are invested in.
Speaker 5 (35:53):
There's another interesting aspect of this as well, which is
if you want to draw a parallel with high you
bonds different a different market. But as the ETFs grew
and people became concerned about their impact in daily liquidity
vehicles on the overall market, what you tend to see
(36:13):
in times of stress, once those funds hit critical mass
is much of the volume trading volumes would go up
in ETFs. They would go down in the cash market
due to a drop off from liquidity and a stress market.
The percentage of primary market activity i e. Redemptions and
(36:33):
creations as a percentage of volume in those ETFs also plummeted,
which means the ETF market makers were managing and laying
off their risk in the secondary market for those shares.
So in a way, the price movements might have been
contributing or advertising the volatility in the market, but there
(36:54):
wasn't the degree of force selling that people might have
either feared or wished for or imagined. Because the critical
mass had been achieved and the secondary market trading became
a great way to manage risk in an aspirational sense,
that's what we were hoping for the COLO universe.
Speaker 3 (37:16):
We think to some degree that did occur in April.
Speaker 5 (37:20):
The market now has recovered and grown more since then,
and we think, you know, there's a possibility that that
type of evolution continues.
Speaker 2 (37:31):
Yeah, And actually you mentioned evolution, and I think a
previously early to differentiation. I was also thinking, so now
that we have a dismal mass of co ETFs, I
would have thought the various managers are going to start
to think more about how to differentiate themselves and in
the process there might be more of a product differentiation
(37:52):
as well. So clearly BSL clos are the dominant type
of cilo still and my guess is a large part
of the investments made by clotfs go into BSL clos.
But we also have other cls nowadays. So we have
mid market clos that have been around for quite a bit,
then quite large now and more recently we've seen sire
(38:14):
commercial real estate clos appear on the scene. And of
course a lot of people have been talking about private
credit clos, some wondering and I really been maybe looking
a fair few years ahead now, not just to twenty
twenty six, but a bit further. Is there a prospect
that the clotf market will start to offer a broader
(38:37):
range of ETFs where some focus more on BSL clos,
some focus more on mid market, some might be focusing
for more on CER clos, some might be more dynamically
allocating between the various types of clos. How do you
see that developing?
Speaker 4 (38:56):
I think that's definitely, you know, I think I definitely
expect to see continued product development in this space. That
you know, anytime you have strong inflows. It does attract
new ideas, I guess I would say, and as you said,
we're seeing middle market private credit celos being put into ETF.
I think there's even a leveraged l O ATF now,
(39:21):
and you know people are looking at it, not directly related,
but you know, private true direct lending now in ETFs. Ultimately,
I think the market, of course will determine whether there's
demand for these products, and especially as you get more
niche I think, you know, they really need to have
(39:42):
a compelling value proposition within a portfolio. But I guess
I would also say, you know, you know, we've talked
about liquidity a few times today and in the product
development process, I mean, we view a liquidity assessment as
really a crucial part of that, really like the initial
part of any product development or any idea. When you're
(40:05):
talking about et s, right, ets have daily inflows and outflows.
They trade through the day, so you need pricing trans fancy.
So you really do need a large and liquid underlying
market because otherwise you can run into issues. And I
think you know it's fans had a lot of uh,
the products, some of these especially some of these more
(40:26):
you know, let's call them. Innovative products that have launched
in recent years haven't really been through any tests, whether
you know, some market event like a big credit shock
or a liquidity event, and you just really don't want
to be in a scenario where you have trouble to
satisfy redemptions or you're you find yourself selling assets at
(40:49):
fire cell prices. So you know, the way we chose
to differentiate was going beyond triple A, right, but still
saying within b SL clos and just taking a broader approach.
And you know, our products were designed to be more
of a strategic holding in a portfolio. So accordingly, we
looked at you know, making sure that the underlying market
(41:12):
was large and liquid and really and set the right
guardrails really to to to manage liquidity risk.
Speaker 1 (41:22):
So this could be for either one of you. But
what do you consider the key headwinds and tailwinds for
the cl market, both investment grade and non investment grade
over the next you know, say, twelve to twenty four months.
Speaker 5 (41:36):
Stark in reverse sort of the tailwinds. We're still in
a the nine credit environment. You still got base rates
that are just below four percent, so you've got solid
credit underpinning still an attractive spread over you know, a moderate,
modestly attractive base rate. That's still a positive rate by
(42:00):
a decent clip. So you know, those are those are
the tailwinds that even if people are worried about the
first headwind I'll mention, which is simply you know, more
rate cuts would tend to lower the coupons unless the
credit spreads widened out to compensate for that. So, uh,
you know, we still think there's a relative attractiveness to
(42:23):
clos that is going to continue into twenty twenty six.
Even if we see you know, another recut in December
and one or two over the course of the next
year to rate those points earlier. If there's more than
that next year, that may change some of the dynamics,
But for now we see that combinations as still you know,
(42:44):
a good, good tailwind for the COLO space. Potential headwinds
Aside from that, you know, overly aggressive FED cutting is
more just macro. Right. If if we see a turn
driven by you know, a couple of the key concerns
we've seen out there, the labor market, uh, you know,
(43:04):
well the consumer in the US finally show some weakness
that starts impacting various sectors of the economy.
Speaker 3 (43:13):
Will tariffs have you know.
Speaker 5 (43:16):
An outsize impact that people seem to be as we
talked about earlier, maybe discounting some of that impact. Now,
is there been a delayed effect and will that come
to rusful geopolitics, anything that could upset this benign credit story.
But when you look at earnings and you know, leverage ratios,
even in the risky credit space, even the fault rates
(43:36):
which had ticked up, but we're still somewhat modest and
certainly manageable within the COO context.
Speaker 3 (43:43):
Uh, you know that that hasn't been the case yet.
Speaker 1 (43:48):
Well, unfortunately we need to end here. But this was
a fantastic conversation. I really thank both of you for
joining us today.
Speaker 3 (43:55):
Thanks very much joining us. Really enjoyed it. Yeah, this
was a lot of fun. Thank you guys and Retto.
Speaker 1 (44:00):
I'd like to thank you for being my co host today.
Speaker 2 (44:02):
No worries at all, what's my pasure and.
Speaker 1 (44:04):
I want to thank you for listening. If you liked
the episode, please subscribe and leave a review. Also, if
you'd like to see more of our research on the terminal,
please go to bi fund Go for fund research and
bi st r t n GO for credit research until
our next episode. This is David Cohne with Inside Active
Host
Gina Martin Adams
Popular Podcasts
Stuff You Should Know
If you've ever wanted to know about champagne, satanism, the Stonewall Uprising, chaos theory, LSD, El Nino, true crime and Rosa Parks, then look no further. Josh and Chuck have you covered.
Las Culturistas with Matt Rogers and Bowen Yang
Ding dong! Join your culture consultants, Matt Rogers and Bowen Yang, on an unforgettable journey into the beating heart of CULTURE. Alongside sizzling special guests, they GET INTO the hottest pop-culture moments of the day and the formative cultural experiences that turned them into Culturistas. Produced by the Big Money Players Network and iHeartRadio.
Crime Junkie
Does hearing about a true crime case always leave you scouring the internet for the truth behind the story? Dive into your next mystery with Crime Junkie. Every Monday, join your host Ashley Flowers as she unravels all the details of infamous and underreported true crime cases with her best friend Brit Prawat. From cold cases to missing persons and heroes in our community who seek justice, Crime Junkie is your destination for theories and stories you won’t hear anywhere else. Whether you're a seasoned true crime enthusiast or new to the genre, you'll find yourself on the edge of your seat awaiting a new episode every Monday. If you can never get enough true crime... Congratulations, you’ve found your people. Follow to join a community of Crime Junkies! Crime Junkie is presented by audiochuck Media Company.