Asset-Backed Securities and CLOs: Relative Outperformance Amid Volatility

This Asset-Backed Securities and CLOs sector report is excerpted from the Fourth Quarter 2022 Fixed-Income Sector Views.

During the third quarter, CLO spreads widened: AAA through A tranches widened by 20–55 basis points, while BBB tranches and BB tranches widened by 50 and 100 basis points, respectively. Despite higher spreads, floating-rate coupons and shorter maturities insulated CLO performance, with AAAs and BBBs returning 0.2 percent and -1.4 percent, respectively.¹

Although CLOs’ corporate bank loan collateral is starting to see downgrades and default rates increase from historically low levels, CLO structures are positioned defensively as performance test thresholds have nearly recovered to healthy pre-COVID levels. For example, CLOs’ exposure to CCC loans has fallen to 4 percent from a COVID peak of over 10 percent, while junior overcollateralization (OC) cushions—the measure of losses CLO collateral can take before cash flow diversion—is back close to 5 percent after falling to near 2 percent. In addition, CLO managers are actively adjusting exposures by avoiding or reducing exposure to riskier borrowers and industries and by upgrading overall portfolio quality. The new issue market is challenging for issuers as investor demand for AAA CLOs is tepid and capital is readily available for only the most heavily resourced and established CLO managers. We expect new issue activity to slow into year end. At the same time, we are seeing secondary market opportunities to purchase discounted investment-grade tranches with the potential for price appreciation and a low likelihood of being called before maturity. We continue to prefer senior CLO tranches from higher tier managers with a proven track record of navigating difficult market environments.

Esoteric ABS (which includes such collateral types as shipping containers, railcars, cellular towers. and whole business franchises) exhibited unchanged credit spreads in the third quarter and outperformed broader credit markets, with the ICE BofA AA-BBB ABS Index returning -2.1 percent. After brisk issuance in the first half of the year, ABS issuance slowed in the third quarter by 24 percent year over year, down 2 percent year to date from the same period last year. Notable new deals came in utility, whole business, and music rights securitizations, but risks remain as we also saw certain transactions in triple-net lease and whole business ABS pre-marketed and then pulled due to lack of investor demand. We expect new supply to remain subdued in the near term.

Credit quality remains sound in key sectors, including whole business, infrastructure, and container ABS, and our focus is on opportunities to add attractive spreads and higher all-in-yields at discount dollar prices in the secondary market.

—By Dominic Bea, Rafsun Faiz, Scott Kanouse, and Michael Liu

Important Notices and Disclosures

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.

Guggenheim Investments represents the following affiliated investment management businesses: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.

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