CLOI Outperforms in Q4, Stays Defensive Amid Uncertainty

CLOs and loans significantly outperformed other credit asset classes in 2022, and the asset class enters the new year at materially higher yields and spreads versus one year ago. The VanEck CLO ETF (the “Fund”) outperformed the J.P. Morgan CLO Index in the fourth quarter by 0.13%, and since launching in June 2022 has outperformed by 0.57%, driven by both portfolio positioning and security selection. With credit conditions expected to deteriorate this year, the portfolio remains conservatively positioned.

Market Update: CLOs Rally Amid Lower Than Expected Inflation

CLOs continued their fourth quarter rally in December, as easing inflation concerns improved investor sentiment despite the continued hawkish narrative from the Federal Reserve. Inflation was lower than anticipated in November with the narrative shifting during the second half of the month amid hawkish surprises from central banks and weak global economic data, although CLOs held on better than most other risk assets. The Federal Reserve raised interest rates by 50bps during the month, the seventh rate increase in 2022, albeit at a slower pace than the prior four meetings.

Source: JP Morgan and ICE Data Indices as of 12/31/2022. CLOs represented by J.P. Morgan Collateralized Loan Obligation Index, AAA Rated CLOs represented by J.P. Morgan CLO AAA Index, AA Rated CLOs represented by J.P. Morgan CLO AA Index, A Rated CLOs represented by J.P. Morgan CLO A Index, BBB Rated CLOs represented by J.P. Morgan CLO BBB Index, BB Rated CLOs represented by J.P. Morgan CLO BB Index, Investment Grade Corporates represented by ICE BofA US Corporate Index, US Agg is represented by the ICE BofA US Broad Market, Leveraged Loans represented by JP Morgan Leveraged Loan Index and High Yield Bonds represented by ICE BofA US High Yield Index. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities mentioned herein.

Per Barclays Research, CLO new issue supply decreased month-over-month, with $4.7B pricing during the month compared to $8.6B in November. While primary issuance ended the year down 31% from 2021 levels, it was the second highest level on record. Refis and resets ended a five-month streak of none pricing, with $0.4B pricing in December. Total issuance for the year was 65% lower compared to 2021. In the secondary market, TRACE supply decreased to $11.9B in December from $20.9B in November, per Morgan Stanley. Total TRACE volume during 2022 of $200B with investment grade volumes of $153B were records for the CLO 2.0 market.

There were no new defaults in the Morningstar LSTA Leveraged Loan Index in November. As a result, the trailing 12-month default rate, by principal, decreased marginally to 0.72% from 0.73% in November. We anticipate the default rate to remain below historical averages in the near-term for the leveraged loan market, notwithstanding ongoing interest rate increases and indications that Fed hikes will maintain higher interest rates throughout 2023. We anticipate the default rate to increase over the medium-term, though our expectations remain that defaults will stay below the long-term historical average of ~3%.

Portfolio Strategy: Security Selection and Ratings Exposure Drive Performance

The Fund returned 3.16% in the quarter ended December 31, 2022, outperforming its benchmark, the J.P. Morgan CLO Index, by 0.13%. The Fund’s ability to shift within investment grade buckets, has been a positive driver of outperformance since launching in June 2022. For example, an overweight to BBB rated CLOs provided some outperformance in the less volatile summer months, before shifting to a more conservative allocation as volatility picked up later in the summer. In addition, security selection within rating categories has been a driver of outperformance vs its benchmark, particularly among AA and BBB rated CLOs.

CLOI Total Return and Credit Allocation

Source: FactSet, JP Morgan and VanEck. CLOIE represented by J.P. Morgan Collateralized Loan Obligation Index and AAA Rated CLOs represented by J.P. Morgan CLO AAA Index. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities mentioned herein.

While CLO metrics remain strong overall and spreads tightened over the course of the fourth quarter, CLO spreads remain materially wider than both the beginning of the year and the median level seen over the past five years as ongoing geopolitical and economic risks continue to weigh on market sentiment. As we expect the pace of downgrades to pick up in 2023, we continue to shift portfolios higher in the capital stack and out of CLOs with high levels of B- exposure.

Outlook Ahead: Holding Defensive Position as Uncertainty Continues

CLOs ended the year on a positive note; however, the Fed quickly warned markets they aren’t finished tightening financial conditions, which could result in additional volatility in the first half of 2023. We remain of the view that credit is entering a slowdown from a point of strength. While fundamentals for leveraged finance issuers are starting from a strong position, the macroeconomic environment indicates a flattening of fundamentals at best, with some likely deterioration. We expect leveraged loan default rates to trend higher from here and move towards longer-term asset class averages. A more challenging macroeconomic backdrop, higher Treasury rates, wider spreads and a less receptive capital markets environment all contribute to our expected increase in default rates. From a technical standpoint, we believe demand for CLOs will to continue to be robust as negative real rates will continue to incentivize investors to take advantage of the yield pickup and the relative attractiveness of CLOs compared to other credit assets. As a result, we expect spreads to remain largely range bound, although spreads are currently near the tighter end of our expected range.

With the new year comes one of the most anticipated recessions in history. While we see some opportunities to add risk on the margin, given the level of uncertainty in the market and tight credit spreads, we do not believe this is the time for broad risk-on positioning. Instead, we believe rallies will provide a good opportunity to further reduce risk and favor our prior stance of maintaining marginally defensive positioning, looking to add relative value at the security and manager selection level.

* Returns less than one year are not annualized.

Van Eck Associates Corporation (the “Adviser”) will pay all expenses of the Fund, except for the fee payment under the investment management agreement, acquired fund fees and expenses, interest expense, offering costs, trading expenses, taxes and extraordinary expenses. Notwithstanding the foregoing, the Adviser has agreed to pay the offering costs until at least May 1, 2024.

The performance data quoted represents past performance. Past performance is not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Performance may be lower or higher than performance data quoted. Please call 800.826.2333 or visit vaneck.com for performance current to the most recent month ended.

The "Net Asset Value" (NAV) of a Fund is determined at the close of each business day, and represents the dollar value of one share of the fund; it is calculated by taking the total assets of the fund, subtracting total liabilities, and dividing by the total number of shares outstanding. The NAV is not necessarily the same as the ETF 's intraday trading value. Investors should not expect to buy or sell shares at NAV.

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