CLOs: Finding Value in a Fully Priced Bond Market
Risk Consideration: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. No investing strategy can overcome all market volatility or guarantee future results.
Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.
Asset-backed Security (ABS) is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities. For investors, asset-backed securities are an alternative to investing in corporate debt.
A basis point is one one-hundredth of a percentage point.
Collateralized debt obligations (CDO) are a financial instruments that pool assets, such as loans, mortgages, and bonds, and issue various classes of securities that are backed by these assets. These classes, or tranches, have a wide range of risk/return characteristics, ranging from ‘AAA’ rated on down to riskier classes, which typically offer greater returns. Higher-rated, or senior, tranches have first priority on the cash flows and, in the event of default, on the collateral.
Commercial Mortgage Backed Security (CMBS) is a type of mortgage-backed security that is secured by the loan on a commercial property. A CMBS can provide liquidity to real estate investors and to commercial lenders. As with other types of MBS, the increased use of CMBS can be attributable to the rapid rise in real estate prices over the years.
Spread is the difference in yield between two different investments. The spread to worst measures the difference from the worst performing security to the best, and can be seen as a measure of dispersion of returns within a given market or between markets.
A subordinated note is a loan or a security that ranks lower than other loans or securities in a capital structure. A lower ranking means that it is given less priority with regard to claims on assets and cash flows.
The Volcker Rule is named after former Federal Reserve Chairman Paul Volcker. It prohibits banks from short-term trading of securities and derivatives for the banks’ own accounts. The Rule also restricts banks’ ownership of hedge funds, private equity funds, and covered funds. The purpose of the Rule is to prevent banks from making the kinds of investments that are believed to have contributed to the 2008 financial crisis.
Yield is the annual interest received from a bond and is typically expressed as a percentage of the bond's market price.
The Standard & Poor’s 500® Index is is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO) such as Standard & Poor’s, Moody’s or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment grade bonds (junk bonds) involve higher risks than investment grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.
This article is intended for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product or as an offer of solicitation with respect to the purchase or sale of any investment. This article should not be considered research nor is the article intended to provide a sufficient basis on which to make an investment decision. The Volcker Rule is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, proposed by former Federal Reserve Chairman Paul Volcker. Often referred to as a ban on proprietary trading by commercial banks, it limits banks’ ability to engage in proprietary trading and to invest in hedge funds and private equity.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
This article has been prepared exclusively for Institutional use only. It is not intended for, and should not be used with, any third-party or the public in written or oral form or for any other purpose.