Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Regarding CLOs, what is conveniently not mentioned is like most everything else in Bondland they melted down too during the Covid meltdown. Investment grade CLOs from AAA to BBB had drawdowns from 10% to 30% while below investment grade drawdowns were 40% to 45%. As recently as 2022, while investment grade CLOs eked out a small gain (JAAA) of under 1% below investment grade lost money. The longest tenured bond fund primarily into CLOs ( an interval fund) lost money 4 years since its 2014 inception. In 2020 it had a multi week drawdown of 30%. As recently as 2022 this CLO fund lost 4.48%. 2023 and 2024 just happened to be “the right place right time” for CLOs. I hold slightly under 50% in CLOs but I am more than cognizant of the risks. A substitute for cash they certainly aren’t.
What is cash? If one is thinking "checking account" (instant liquidity w/o loss), then even CDs don't qualify.
On the other end of the spectrum there is cash as an investment - locking up cash in fixed rate investments for longer periods of time (typically years). You can still get at that cash for emergencies, but at a cost. However, the cost is much less than the risk of investing in the market, and the cost is often known in advance (e.g. CD early withdrawal penalty).
Representing the first perspective is this piece by M*: Why Ultrashort Bond Funds Aren’t Cash Substitutes. "[I]n 2008 ... the average ultrashort bond fund dropped 8.4%. ... [In 2020] [w]hile most investment-grade bond categories posted positive returns during the market’s flight to quality, the average ultrashort bond fund lost about 1.8% in the first quarter.
And the 2020 losses peak to trough (March 6 - March 23) were much greater.
These relatively extreme (for their category) losses occur when the economy experiences severe jolts (GFC, pandemic). For "checking account" type cash, even these short lived, though sharp, jolts are unacceptable. For longer term "investment cash", the short term disruptions may be acceptable.
A difference between ultrashort bond funds and IG CLOs is that the CLOs are more complicated investments. In theory, AAA tranches should hold up well in any environment other than one where everything gets hit. And they should recover better. There's some solace in JAAA doing just that in 2022. But that's only one stress test and there are many ways the economic system can get jolted.
Junkster mentioned CLOs doing poorly in 2020. Was their behavior distinctive or just in line with (though more severe than) the rest of the IG market? That is, can we glean anything about their special risks from 2020? If not, then all we can say is that, yes, bonds of all ilk can get hit by system shocks and recover similarly.
If that is unacceptable, only invest in guaranteed principal vehicles (Treasuries, CDs, credit union time deposits, bank accounts, etc.).
Regarding annuities, I had a bad experience in the 1980s, when my company retirement program was negatively impacted by bankruptcy of a major annuity provider--the Baldwin Company.
Ah, the piano company. They were making loans to buyers (good pianos are really expensive) and so branched out into insurance. When it comes to insurance, better to stick with "professionals". Not that your employer gave you a choice.
The Baldwin-United Corporation, the Cincinnati piano company that borrowed heavily to move into the insurance business, filed for protection under the bankruptcy laws yesterday [Sept 26, 1983] in one of the largest financial collapses in American history.
The company was a casualty of overexpansion, built on complex financial maneuvers.
The problems came ... when companies like Baldwin began using SPDA assets to prop up nonrelated ventures. Partly for this reason, brokers and financial planners are learing to be more skeptical about insurance company ratings provided by A. M Best's ...
In an interview, [Mary Malgoire, a financial planner] and her partner, David Drucker, agreed that the SPDA is basically a good product - provided it is sold by a company with experience in annuities (preferably an insurance company) and provided SPDA assets are totally ''segregated,'' or kept separate from the rest of the company's business. This requires the investor to look into the company occasionally, look at annual reports, and find out how and where SPDA assets are invested.
FWIW, Fidelity's SPDA offerings are generally from top tier insurance companies. (The only company not with a AA rating from either Best or S&P is Fidelity's.) Consequently these SPDAs don't pay the highest rates in the industry but provide more peace of mind.
There weren’t many investment grade CLOs available at retail prior to 2020 when JAAA opened. HSRT came up in a web search. It gained +3.77% in 2020. I would never recommend one as a cash substitute. I confess to having misread the original post as at least opening the door for something “more active” (aggressive) then the safety of cash. If you want safety, short-term T-Bills are usually regarded as the safest investment, with insured bank / credit union accounts a close second. How a chaotic government shutdown (budget related) might upset that assumption is sometimes a topic of conversation.
True, cash is what one desires for absolute safety, especially if it’s to fund near term commitments (housing, medical care, child support, etc.) As an investor I have sometimes “stretched” the definition of cash as a part of a diversified portfolio. ”Relatively safe” compared to most other investments I hold works for me. Willing to take a short term haircut in pursuit of longer term goals. Like OJ, I’m getting up there in years, so “long term” still exists but in a different way. My current risk perameters allow me to hold about 5% in JAAA alongside 5% in a money market fund. But that’s not for everyone.
As @Junkster says, CLOs are not substitutes for cash (as defined in the strictest sense). I’d submit that neither is the River Park fund often mentioned. And he is correct that CLOs took a brief clobbering in March 2020 and for a few months beyond. Even my quite respectable ultra-short fund (TRBUX) at the time got knocked down. Truth is corporate bonds of every stripe got hit hard for a short period until the Fed stepped in and took the unprecedented step of backing investment grade debt. A black-swan like the Covid affair can strike at any time. They’re all different and usually unexpected. As bad as the hit was for CLOs for a month or two, equities got hit much harder. My p/m mining fund fell out of bed overnight. I’d go back and check how much it lost in a day or two, but it would be too painful.
I would trust AAA rated corporates over AAA rated securitized stuff.
There are lots of assumptions built into AAA rated tranche of structured credits that may have only A or BBB rated underlying portfolios. So, I won't take AAA CLO at face value, like AAA MSFT or JNJ.
I would trust AAA rated corporates over AAA rated securitized stuff.
There are lots of assumptions built into AAA rated tranche of structured credits that may have only A or BBB rated underlying portfolios. So, I won't take AAA CLO at face value, like AAA MSFT or JNJ.
For sure, Yogi. True. And one of the first things that surfaces if you do a bit of digging before investing. Don’t let the A - AAA rating fool you into thinking everything held insides meets that high standard. Normally doesn’t.
"I would trust AAA rated corporates over AAA rated securitized stuff."
Human beings need reminding the same thing every few years to protect them from themselves. By now, in the minds of many, GFC is just an acronym devoid of the depth of its true meaning.
Human beings need reminding the same thing every few years to protect them from themselves. By now, in the minds of many, GFC is just an acronym devoid of the depth of its true meaning.
All the more reason to understand the difference betweenCDOs which caused the 2007-2009 financial crisis and CLOs which did not.
If you were invested to a significant degree when the GFC began (late 2007) it’s pretty hard to forget. I recall a chance meeting on the street in early ‘08 with an aquantence from my high school years, then retired, who recounted the pain he and his wife were going through having lost about half their life savings in a matter of months, (Some “high-yielding” mutual fund as I recall.)
It is better to understand the basics and contemplate than to eat what product selling financial institutions feed us. (loop back to YBB's post re ratings and securitization).
No disrespect specific to VanEck intended (I use their products.)
I would trust AAA rated corporates over AAA rated securitized stuff.
There are lots of assumptions built into AAA rated tranche of structured credits that may have only A or BBB rated underlying portfolios. So, I won't take AAA CLO at face value, like AAA MSFT or JNJ.
There's a distinction to be drawn between issuer credit rating (ICR) and issue credit rating. The credit rating of a particular debt issue can deviate (both up and down) from the issuer's credit rating for a variety of reasons.
One of those reasons is seniority. Obviously holders of senior debt are more likely to be made whole than holders of junior (subordinated) debt. The same idea applies to CLOs. Though the mechanism is more complicated because in CLOs one is dealing with a basket of IOUs as opposed to a single corporate bond.
An Issuer Rating reflects Morningstar DBRS’ assessment of that issuer’s likelihood of default. ...
Generally speaking, an Issuer Rating is the reference point used in assigning ratings to that issuer’s debt securities, such as long-term obligations, including preferred shares and short-term obligations. Nonetheless, depending on the structural and legal details of each rated security, credit ratings on actual securities (secured or unsecured) may be higher, lower, or equal to the Issuer Rating for a given entity.
With that said, sure, I'd prefer holding "natural" AAA debt. But there ain't too many AAA rated corporations. So one must consider factors like prioritization in addition to the issuer credit rating (ICR) in evaluating a specific debt obligation.
It is better to understand the basics and contemplate than to eat what product selling financial institutions feed us. (loop back to YBB's post re ratings and securitization). No disrespect specific to VanEck intended (I use their products.)
I agree with @yogibearbull’s explanation of how CLOs work. If he meant to ascribe blame for the Great Financial Crisis to CLOs I must have missed it. Do your own research. No need to trust VanEck.
Yes, Investment grade rated CLOs entail more risk than highly rated corporate bonds. No. They did not cause or contribute to the GFC. No. You should not own them unless you understand the risk / reward trade-off and think they in some small way complement your overall investment portfolio. Just don’t conflate them with CDOs. No one benefits from such inaccurate unfounded inferences.
Historical precedent imo does not hold much value. Prior to the 2008 GFC, real estate prices had NEVER gone down nationally and the "pundit" consensus at the time was it could not happen (real estate pricing is local blah blah...) and yet.
AAA CLO can incur a loss regardless of the prior 30Y history.
Historical precedent imo does not hold much value.
Others beg to differ. They look at how a fund performed in specific economic environments (such as the 2008 GFC you mention) and/or over full economic cycles to get a sense of how the fund might behave going forward. These are not guarantees but data points that help gauge risk.
Prior to the 2008 GFC, real estate prices had NEVER gone down nationally and the "pundit" consensus at the time was it could not happen (real estate pricing is local blah blah...) and yet.
2008 demonstrated that diversification is not a cure-all. Geographic diversification did not prevent losses in the real estate sector. Actually, in 2008 even diversification across sectors would not have improved matters much.
Real estate investment trusts wrapped up 2008 with negative returns, including dividends, of 37.3% on average, according to a report released Wednesday by the National Association of Real Estate Investment Trusts in Washington. The performance was in line with the broader indexes, such as the Standard & Poor’s 500 stock index, which was down 37%, the Russell 2000 Index, which was off 33.8%, and the Nasdaq Composite Index, which declined 40.5%.
A minor point on your datum for completeness. Real estate prices did go down (Y/Y) prior to 2008. It's just a specific slice of real estate - housing transactions involving conforming Fannie May/Freddie Mac loans - that hadn't dropped before then. Case-Schiller's broader housing index dropped in previous years (1991, 2007), as did commercial real estate. Assessing the Credit Risk of CDOs Backed by Structured Finance Securities: Rating Analysts’ Challenges and Solutions: fn 5 and Figure 1.
AAA CLO can incur a loss regardless of the prior 30Y history Of course. And MMFs can break a buck - retail funds had a 37 year run, 1971-2008 before incurring a loss. But that didn't make their history useless.
The 30 year run of AAA CLOs without losses doesn't prove they never will lose money. Rather, it serves as evidence that these relatively complex structured vehicles are not brittle. They have not collapsed in a variety of stressful environments. Nevertheless, there may be a latent design defect that will show up when the exactly right conditions arise.
I wouldn't bet my last dollar on that never happening, just as I wouldn't bet my last dollar on MMFs never failing or being frozen. But that possibility doesn't deter me from using MMFs for some of my cash. It's a matter of what risks you perceive (it's never zero) and how sensitive you are to those risks.
Risk is an odd and variable concept. People tend to view things which haven't exhibited poor outcomes as being "riskless", but just because something hasn't manifested, does not mean that its potential isn't present. Unless you believe in "something for nothing", good performers are taking risks; whether obvious or not. We simply don't observe the consequences of that risk until something goes wrong. Absence doesn't imply nonexistence.
Thank you to @msf for all the research. Very thorough look at investment grade CLOs.
I can understand the “just because it never happened before …” comments if we hue strictly to @dtconroe’s goal here which seems to be to remain in a cash equivalent security with the highest degree of safety and stability and also best the best reward. It’s a tall order. That would appear to limit us to discussing FDIC backed CDs or T-Bills. The Fed took measures after ‘08 to strengthen money market funds. But, as you say, they are not “fool-proof” and would have failed en-masse in late ‘07 had not the government under emergency authority stepped in to back them.
However, if we are allowed to “stray” a bit and compare A+ rated CLOs to equities or lower tier junk bonds there’s really no comparison - so far apart are they on any reasonable risk scale. Equities can halve their value in a year under adverse conditions. The risk of lower tier HY bonds, while not on a par with equities, is still substantial. A 25% or more haircut in a year’s time across those funds is possible under really adverse market conditions (and an investor stampede)..
By nature we here are as a bunch inclined to take some risk beyond cash / CDs to grow wealth or preserve buying power. So on a risk scale with aggressive growth equities on the top, a fund like JAAA would be far below. No - not as safe as cash. No one is claiming that. But certainly less risky than equities or lower tier junk bonds. So each of us assembles a portfolio consisting of many different components that fits our individual needs. We test as best as we can to understand the loss potential under different adverse conditions. The decision by some at an advanced age to invest solely in cash is understandable. I’d never quarrel with them.
This turned out to be an interesting thread, that became somewhat broader than I expected. It is true that I am one of the more risk averse, conservative fixed income investors/posters, which is why I directed my original post to posters, who also had CDs maturing. I was attempting to see if other CD investors thought the CD market was still a good place to invest, or whether they had decided to move on to other options. There have been some great posts, with very interesting discussions. I personally have benefitted from the thread, and hope others, have derived some benefits as well. For posters like Hank, who want "to stray a bit" from my original post objectives, toward a bit more "riskiness", that is fine with me--I may be one of those investors in the future, if I need more total return than what my current investing strategy may be able to deliver.
racqueteer: "Risk is an odd and variable concept. People tend to view things which haven't exhibited poor outcomes as being "riskless", but just because something hasn't manifested, does not mean that its potential isn't present. Unless you believe in "something for nothing", good performers are taking risks; whether obvious or not. We simply don't observe the consequences of that risk until something goes wrong. Absence doesn't imply nonexistence."
I have read this post a few times, scratched my head a bit about the various applications in the financial world, with it kind of reminding me of the "Deep Thoughts" skits on Saturday Night Live. In the investing/financial world, I am not sure you can avoid the impact of financial factors associated with "risk" that contributes to what you do with other financial decision making. For example, posters often take very strong positions regarding investing in equities, various categories of bond oefs, the importance of investment grade designations for various bond investments, financial health ratings for various banks and their products, role of various fixed income categories that have government insurance protections (FDIC,NCUA) for institutions like banks and credit unions, compared to some brokerage products like Brokerage Money Market funds. In the mutual fund world, standard deviation is commonly used measure to establish the "riskiness" of bond oefs, but often only within that category of bond oefs.
One of my personal issues is how social security and company pension programs impact how much "risk" one will take in other types of investments, such as equities and bond oefs. How much do those pension programs form "safety nets" that allows an investor take more risks in other categories of investing. I have no company pension support payment, my social security payments are relatively small (some of my employers were not participating in social security). I try to use CDs and comparable "low risk" investments to form my safety net, since I do not have a safety net pension program in financial assets. It can all be very different for different investors/posters, and yet when people make posts, you rarely have a comprehensive and detailed set of information about that poster/investor, that forms the basis for giving away free financial advice to others.
Along the lines of what Racq said, I think there is a great YouTube video where Howard Marks discussed what risk means. I had shared it in this forum. You can search the forum.
I heartily agree with you, dt, that individual circumstance has a great deal of impact, at least in principle, on one's financial positioning, what one considers 'risky', and how much risk one is willing to incorporate into one's investments. All of that in addition to one's personal comfort level for allocation. So, yes, I would agree that the advice one may receive online is distorted by those, often absent, details, or by their variability amongst participants.
Almost everyone means well, but it is as if we have different native tongues, and are, nonetheless, trying to explain our thinking. Over time, we come to understand the particular point of view of a recognizable poster, but we certainly need to be circumspect with regard to 'strangers', lest we be misunderstood (and, therefore, mislead). My own circumstances are enough different, that I hesitiate to offer advice without tons of qualification!
The problem with Marks and many others is in the details. How do you control risk in real life when markets punch you in the face?
If you know your goals, risk, volatility and are willing to tolerate it, and you are a buy-and-hold investor, you should have less of a problem. That's a lot easier for the accumolator.
In retirement, things get more difficult. When to retire? when to take SS? future taxes, pensions, LTC?. Are you really needing the future risk/SD? If you have enough?
I have been thinking, practicing, tweaking, and testing performance under risk/SD for about 25 years. This is what has worked for me. 1) The best way to avoid losses is to sell to MM. I couldn't find any fund(s) that can minimize the losses for the entire portfolio to under 3%, not even 5%, and still have reasonable performance as 50/50. 2) Investing based on what happened months ago or 1-2 (or more) years is a no-go. The worst years present great opportunities because of item 1 above. 3) There is almost nothing 100% safe. Stocks go down, bonds, even treasuries go down (2022). Not all MM are safe too; some can limit your access when you want to trade, others can break the $1. 4) Diversification doesn't save you either. IMO, investing in just 3-6 funds is all you need to make your life simpler. 5) Valuation and others are another trap.
The solution: Do almost nothing or Know what you are doing, be a good trader, and know the risk/SD, it is different many times; expect the worst and hope for the best. Expect the worst is the key. A 5-10% decline can end in 20-30% and even 50%. If you wait too long, you are too late. This is the main point: you can't define the risk/SD, it's not predictable.
Well, I read that whole post. Then I read it a second time.
After two readings, the only part I even half-way understood was: "If you wait too long, you are too late."
Why? Because it wakes up the infamous YB echoes of: "It ain't over 'til it's over," "The future ain't what it used to be," and "It's deja vu all over again."
For those few posters still reading this, who have interest in CDs, I just checked Schwab CD offerings. Lots of callables paying 4.4% and more, but interestingly there are non-callables being offered at 4% for 2 and 3 years by major well-known banks. That strongly suggests that CD rates may not be dropping that much more in the near future.
Well, I read that whole post. Then I read it a second time.
After two readings, the only part I even half-way understood was: "If you wait too long, you are too late."
Why? Because it wakes up the infamous YB echoes of: "It ain't over 'til it's over," "The future ain't what it used to be," and "It's deja vu all over again."
LMFAO while wiping chunks off my screen!
I wonder who is the above? Is it stillers, albie, Arriba, or maybe Karen? ROFL looking at my portfolio.
Just a little additional information on Credit Unions. Credit Unions are very "similar" but not identical to banks. Credit Unions offer the same wide array of products that Banks do--checking accounts, savings accounts, credit cards, debit cards, bill pay, Share Certificates/CDs, and they offer a wide range of loans such as car, mortgage, and personal loans. They have government insurance protections (NCUA), which is virtually identical to FDIC for Banks. Almost every mid-size city or larger, will have several different credit unions that should be evaluated for customer service, financial health, and slight variances in interest rates and fees that accompanies their products.
Yesterday, I visited the Kelley Community Credit Union in Tyler, Texas, a city of about 100,000 in population, one of the fastest growing cities in Texas, and a very popular city for Retirees. Kelley Credit Union has a very new and attractive brick and mortar facility, much nicer than the Bank I use. It also has more staff and more professional services in its facility, than the bank I use--for example they have a Professional Licensed Financial Advisor, who previously worked for Morgan Stanley, which my Bank does not have. The main reason I went to this Credit Union is because they offer one of the highest one year "non-callable Share Certificate/CDs at 4.5%, higher than what I can get at my Bank or at Schwab Brokerage. They were very professional and informed me of a special incentive program, if I use several of their products (checking accounts, debit cards, Direct Deposits, E-Statements, and at least $15,000 in deposits and loans) which would lead them to add" .3% to the existing 4.5% Share Certificate/CD so that the actual rate would be 4.8%.
This is a quality and low risk option for my investments, and you may find similar options from a Credit Union in your area!
I can endorse CU as financial institutions, especially for their excellent customer service. I have dealt with them over the years. I never had large enough invested with them to worry about their balance sheet or how NCUA works. It seems they get into trouble far less than regional / community banks. Do your DD.
In the interest of full disclosure, I stopped doing business with them when cyber attacks of US businesses became more prevalent. Just my luck, a few years after I closed my account, Patelco CU had a cyber attack and my info was compromised.
@dtconroe : With your last comment it leads me to ask, what % are you receiving for your $15K deposit & I'm taking it to mean saving, MMF, or checking account ? My bank offered to move MMF at a higher rate if I opened checking account paying .01% I put $100 in checking & there it sits. With rates falling I need to make a move of some kind as MMF is down to 1.7% as of Dec. !!
I can endorse CU as financial institutions, especially for their excellent customer service. I have dealt with them over the years. I never had large enough invested with them to worry about their balance sheet or how NCUA works. It seems they get into trouble far less than regional / community banks. Do your DD.
In the interest of full disclosure, I stopped doing business with them when cyber attacks of US businesses became more prevalent. Just my luck, a few years after I closed my account, Patelco CU had a cyber attack and my info was compromised.
BaluBalu'
Thanks for your personal experience, and I am sorry for your bad experience. I totally agree with "Do your DD". I have never experienced issues with Credit Unions that you experienced, but just like Banks, Credit Unions should be researched. My "bad experiences" have occurred with Banks. Woodforest National Bank use to be my primary bank, until I experienced Identity theft issues. Someone got into my checking account information, wrote some huge and numerous bad checks over the course of just a couple of days, forcing me to file a Police Report, get a new Drivers License, and close my banking account. In the process of dealing with these issues, the local police department informed me that they had many similar problems with Woodforest National Bank and encouraged me to get a new bank with better security for depositor accounts. Of course, I experienced numerous "bank problems" during the 2007/2008 financial crisis, with several banks that went bankrupt and had to close--the most well known bank was the Countrywide Bank, where I had several CDs. Fortunately, my CD investments were okay with FDIC protections, but it took a little time to clean up the Countrywide mess! I did my Due Diligence on local credit unions in Tyler, and although I have been using another Credit Union (CASE Credit Union), it was not as good as Kelley Credit Union when it came to Share Certificates/CDs. As you said do your Due Diligence, and gather some quality information before making your financial decision.
Comments
On the other end of the spectrum there is cash as an investment - locking up cash in fixed rate investments for longer periods of time (typically years). You can still get at that cash for emergencies, but at a cost. However, the cost is much less than the risk of investing in the market, and the cost is often known in advance (e.g. CD early withdrawal penalty).
Representing the first perspective is this piece by M*: Why Ultrashort Bond Funds Aren’t Cash Substitutes. "[I]n 2008 ... the average ultrashort bond fund dropped 8.4%. ... [In 2020] [w]hile most investment-grade bond categories posted positive returns during the market’s flight to quality, the average ultrashort bond fund lost about 1.8% in the first quarter.
And the 2020 losses peak to trough (March 6 - March 23) were much greater.
These relatively extreme (for their category) losses occur when the economy experiences severe jolts (GFC, pandemic). For "checking account" type cash, even these short lived, though sharp, jolts are unacceptable. For longer term "investment cash", the short term disruptions may be acceptable.
A difference between ultrashort bond funds and IG CLOs is that the CLOs are more complicated investments. In theory, AAA tranches should hold up well in any environment other than one where everything gets hit. And they should recover better. There's some solace in JAAA doing just that in 2022. But that's only one stress test and there are many ways the economic system can get jolted.
Junkster mentioned CLOs doing poorly in 2020. Was their behavior distinctive or just in line with (though more severe than) the rest of the IG market? That is, can we glean anything about their special risks from 2020? If not, then all we can say is that, yes, bonds of all ilk can get hit by system shocks and recover similarly.
If that is unacceptable, only invest in guaranteed principal vehicles (Treasuries, CDs, credit union time deposits, bank accounts, etc.).
Ah, the piano company. They were making loans to buyers (good pianos are really expensive) and so branched out into insurance. When it comes to insurance, better to stick with "professionals". Not that your employer gave you a choice. https://www.nytimes.com/1983/09/27/business/baldwin-a-casualty-of-fast-expansion-files-for-bankruptcy.html https://www.csmonitor.com/1984/1010/101040.html
FWIW, Fidelity's SPDA offerings are generally from top tier insurance companies. (The only company not with a AA rating from either Best or S&P is Fidelity's.) Consequently these SPDAs don't pay the highest rates in the industry but provide more peace of mind.
True, cash is what one desires for absolute safety, especially if it’s to fund near term commitments (housing, medical care, child support, etc.) As an investor I have sometimes “stretched” the definition of cash as a part of a diversified portfolio. ”Relatively safe” compared to most other investments I hold works for me. Willing to take a short term haircut in pursuit of longer term goals. Like OJ, I’m getting up there in years, so “long term” still exists but in a different way. My current risk perameters allow me to hold about 5% in JAAA alongside 5% in a money market fund. But that’s not for everyone.
As @Junkster says, CLOs are not substitutes for cash (as defined in the strictest sense). I’d submit that neither is the River Park fund often mentioned. And he is correct that CLOs took a brief clobbering in March 2020 and for a few months beyond. Even my quite respectable ultra-short fund (TRBUX) at the time got knocked down. Truth is corporate bonds of every stripe got hit hard for a short period until the Fed stepped in and took the unprecedented step of backing investment grade debt. A black-swan like the Covid affair can strike at any time. They’re all different and usually unexpected. As bad as the hit was for CLOs for a month or two, equities got hit much harder. My p/m mining fund fell out of bed overnight. I’d go back and check how much it lost in a day or two, but it would be too painful.
There are lots of assumptions built into AAA rated tranche of structured credits that may have only A or BBB rated underlying portfolios. So, I won't take AAA CLO at face value, like AAA MSFT or JNJ.
Human beings need reminding the same thing every few years to protect them from themselves. By now, in the minds of many, GFC is just an acronym devoid of the depth of its true meaning.
If you were invested to a significant degree when the GFC began (late 2007) it’s pretty hard to forget. I recall a chance meeting on the street in early ‘08 with an aquantence from my high school years, then retired, who recounted the pain he and his wife were going through having lost about half their life savings in a matter of months, (Some “high-yielding” mutual fund as I recall.)
No disrespect specific to VanEck intended (I use their products.)
One of those reasons is seniority. Obviously holders of senior debt are more likely to be made whole than holders of junior (subordinated) debt. The same idea applies to CLOs. Though the mechanism is more complicated because in CLOs one is dealing with a basket of IOUs as opposed to a single corporate bond. https://dbrs.morningstar.com/media/DBRSM-Product-Guide.pdf
With that said, sure, I'd prefer holding "natural" AAA debt. But there ain't too many AAA rated corporations. So one must consider factors like prioritization in addition to the issuer credit rating (ICR) in evaluating a specific debt obligation.
"[N]o AAA rated CLO has ever defaulted in the asset class’s 30+ year history."
https://cdn.janushenderson.com/webdocs/Securitized+Primer_+Collateralized+Loan+Obligations.pdf
In contrast, 0.38% of AA rated corporate debt defaulted in 2008 and 0.17% of AA debt defaulted in 1999.
https://www.spglobal.com/ratings/en/research/articles/240328-default-transition-and-recovery-2023-annual-global-corporate-default-and-rating-transition-study-13047827
(see Table 3)
I agree with @yogibearbull’s explanation of how CLOs work. If he meant to ascribe blame for the Great Financial Crisis to CLOs I must have missed it. Do your own research. No need to trust VanEck.
Here’s an article from Wharton
Here’s one from the Financial Times
From JP Morgan
Yes, Investment grade rated CLOs entail more risk than highly rated corporate bonds. No. They did not cause or contribute to the GFC. No. You should not own them unless you understand the risk / reward trade-off and think they in some small way complement your overall investment portfolio. Just don’t conflate them with CDOs. No one benefits from such inaccurate unfounded inferences.
AAA CLO can incur a loss regardless of the prior 30Y history.
Others beg to differ. They look at how a fund performed in specific economic environments (such as the 2008 GFC you mention) and/or over full economic cycles to get a sense of how the fund might behave going forward. These are not guarantees but data points that help gauge risk.
Prior to the 2008 GFC, real estate prices had NEVER gone down nationally and the "pundit" consensus at the time was it could not happen (real estate pricing is local blah blah...) and yet.
2008 demonstrated that diversification is not a cure-all. Geographic diversification did not prevent losses in the real estate sector. Actually, in 2008 even diversification across sectors would not have improved matters much. https://www.investmentnews.com/alternatives/reit-returns-fell-373-in-2008/19418
A minor point on your datum for completeness. Real estate prices did go down (Y/Y) prior to 2008. It's just a specific slice of real estate - housing transactions involving conforming Fannie May/Freddie Mac loans - that hadn't dropped before then. Case-Schiller's broader housing index dropped in previous years (1991, 2007), as did commercial real estate.
Assessing the Credit Risk of CDOs Backed by Structured Finance Securities: Rating Analysts’ Challenges and Solutions: fn 5 and Figure 1.
AAA CLO can incur a loss regardless of the prior 30Y history
Of course. And MMFs can break a buck - retail funds had a 37 year run, 1971-2008 before incurring a loss. But that didn't make their history useless.
The 30 year run of AAA CLOs without losses doesn't prove they never will lose money. Rather, it serves as evidence that these relatively complex structured vehicles are not brittle. They have not collapsed in a variety of stressful environments. Nevertheless, there may be a latent design defect that will show up when the exactly right conditions arise.
I wouldn't bet my last dollar on that never happening, just as I wouldn't bet my last dollar on MMFs never failing or being frozen. But that possibility doesn't deter me from using MMFs for some of my cash. It's a matter of what risks you perceive (it's never zero) and how sensitive you are to those risks.
I can understand the “just because it never happened before …” comments if we hue strictly to @dtconroe’s goal here which seems to be to remain in a cash equivalent security with the highest degree of safety and stability and also best the best reward. It’s a tall order. That would appear to limit us to discussing FDIC backed CDs or T-Bills. The Fed took measures after ‘08 to strengthen money market funds. But, as you say, they are not “fool-proof” and would have failed en-masse in late ‘07 had not the government under emergency authority stepped in to back them.
However, if we are allowed to “stray” a bit and compare A+ rated CLOs to equities or lower tier junk bonds there’s really no comparison - so far apart are they on any reasonable risk scale. Equities can halve their value in a year under adverse conditions. The risk of lower tier HY bonds, while not on a par with equities, is still substantial. A 25% or more haircut in a year’s time across those funds is possible under really adverse market conditions (and an investor stampede)..
By nature we here are as a bunch inclined to take some risk beyond cash / CDs to grow wealth or preserve buying power. So on a risk scale with aggressive growth equities on the top, a fund like JAAA would be far below. No - not as safe as cash. No one is claiming that. But certainly less risky than equities or lower tier junk bonds. So each of us assembles a portfolio consisting of many different components that fits our individual needs. We test as best as we can to understand the loss potential under different adverse conditions. The decision by some at an advanced age to invest solely in cash is understandable. I’d never quarrel with them.
I have read this post a few times, scratched my head a bit about the various applications in the financial world, with it kind of reminding me of the "Deep Thoughts" skits on Saturday Night Live. In the investing/financial world, I am not sure you can avoid the impact of financial factors associated with "risk" that contributes to what you do with other financial decision making. For example, posters often take very strong positions regarding investing in equities, various categories of bond oefs, the importance of investment grade designations for various bond investments, financial health ratings for various banks and their products, role of various fixed income categories that have government insurance protections (FDIC,NCUA) for institutions like banks and credit unions, compared to some brokerage products like Brokerage Money Market funds. In the mutual fund world, standard deviation is commonly used measure to establish the "riskiness" of bond oefs, but often only within that category of bond oefs.
One of my personal issues is how social security and company pension programs impact how much "risk" one will take in other types of investments, such as equities and bond oefs. How much do those pension programs form "safety nets" that allows an investor take more risks in other categories of investing. I have no company pension support payment, my social security payments are relatively small (some of my employers were not participating in social security). I try to use CDs and comparable "low risk" investments to form my safety net, since I do not have a safety net pension program in financial assets. It can all be very different for different investors/posters, and yet when people make posts, you rarely have a comprehensive and detailed set of information about that poster/investor, that forms the basis for giving away free financial advice to others.
Almost everyone means well, but it is as if we have different native tongues, and are, nonetheless, trying to explain our thinking. Over time, we come to understand the particular point of view of a recognizable poster, but we certainly need to be circumspect with regard to 'strangers', lest we be misunderstood (and, therefore, mislead). My own circumstances are enough different, that I hesitiate to offer advice without tons of qualification!
How do you control risk in real life when markets punch you in the face?
If you know your goals, risk, volatility and are willing to tolerate it, and you are a buy-and-hold investor, you should have less of a problem. That's a lot easier for the accumolator.
In retirement, things get more difficult. When to retire? when to take SS? future taxes, pensions, LTC?. Are you really needing the future risk/SD? If you have enough?
I have been thinking, practicing, tweaking, and testing performance under risk/SD for about 25 years. This is what has worked for me.
1) The best way to avoid losses is to sell to MM. I couldn't find any fund(s) that can minimize the losses for the entire portfolio to under 3%, not even 5%, and still have reasonable performance as 50/50.
2) Investing based on what happened months ago or 1-2 (or more) years is a no-go. The worst years present great opportunities because of item 1 above.
3) There is almost nothing 100% safe. Stocks go down, bonds, even treasuries go down (2022). Not all MM are safe too; some can limit your access when you want to trade, others can break the $1.
4) Diversification doesn't save you either. IMO, investing in just 3-6 funds is all you need to make your life simpler.
5) Valuation and others are another trap.
The solution:
Do almost nothing
or
Know what you are doing, be a good trader, and know the risk/SD, it is different many times; expect the worst and hope for the best. Expect the worst is the key. A 5-10% decline can end in 20-30% and even 50%. If you wait too long, you are too late.
This is the main point: you can't define the risk/SD, it's not predictable.
After two readings, the only part I even half-way understood was:
"If you wait too long, you are too late."
Why? Because it wakes up the infamous YB echoes of:
"It ain't over 'til it's over,"
"The future ain't what it used to be," and
"It's deja vu all over again."
LMFAO while wiping chunks off my screen!
Is it stillers, albie, Arriba, or maybe Karen?
ROFL looking at my portfolio.
Yesterday, I visited the Kelley Community Credit Union in Tyler, Texas, a city of about 100,000 in population, one of the fastest growing cities in Texas, and a very popular city for Retirees. Kelley Credit Union has a very new and attractive brick and mortar facility, much nicer than the Bank I use. It also has more staff and more professional services in its facility, than the bank I use--for example they have a Professional Licensed Financial Advisor, who previously worked for Morgan Stanley, which my Bank does not have. The main reason I went to this Credit Union is because they offer one of the highest one year "non-callable Share Certificate/CDs at 4.5%, higher than what I can get at my Bank or at Schwab Brokerage. They were very professional and informed me of a special incentive program, if I use several of their products (checking accounts, debit cards, Direct Deposits, E-Statements, and at least $15,000 in deposits and loans) which would lead them to add" .3% to the existing 4.5% Share Certificate/CD so that the actual rate would be 4.8%.
This is a quality and low risk option for my investments, and you may find similar options from a Credit Union in your area!
In the interest of full disclosure, I stopped doing business with them when cyber attacks of US businesses became more prevalent. Just my luck, a few years after I closed my account, Patelco CU had a cyber attack and my info was compromised.
My bank offered to move MMF at a higher rate if I opened checking account paying .01%
I put $100 in checking & there it sits. With rates falling I need to make a move of some kind as MMF is down to 1.7% as of Dec. !!
Thanks for your personal experience, and I am sorry for your bad experience. I totally agree with "Do your DD". I have never experienced issues with Credit Unions that you experienced, but just like Banks, Credit Unions should be researched. My "bad experiences" have occurred with Banks. Woodforest National Bank use to be my primary bank, until I experienced Identity theft issues. Someone got into my checking account information, wrote some huge and numerous bad checks over the course of just a couple of days, forcing me to file a Police Report, get a new Drivers License, and close my banking account. In the process of dealing with these issues, the local police department informed me that they had many similar problems with Woodforest National Bank and encouraged me to get a new bank with better security for depositor accounts. Of course, I experienced numerous "bank problems" during the 2007/2008 financial crisis, with several banks that went bankrupt and had to close--the most well known bank was the Countrywide Bank, where I had several CDs. Fortunately, my CD investments were okay with FDIC protections, but it took a little time to clean up the Countrywide mess! I did my Due Diligence on local credit unions in Tyler, and although I have been using another Credit Union (CASE Credit Union), it was not as good as Kelley Credit Union when it came to Share Certificates/CDs. As you said do your Due Diligence, and gather some quality information before making your financial decision.