Industry Voice: Taking another look at securitised credit

Fundamental research can reveal opportunities in the asset class

clock • 4 min read
Industry Voice: Taking another look at securitised credit

Key points

  • Securitised credit can be a useful fixed income allocation for institutional investors who focus on book yield or those trying to match future pension liabilities.
  • The asset class typically provides a meaningful credit spread advantage over corporate bonds with similar credit quality, as well as diversification benefits.
  • Building a customized securitised credit portfolio is an iterative process in which we work closely with the client to refine investment guidelines.

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Securitised credit can be a useful fixed income allocation for institutional investors who focus on book yield or those trying to match the cash flows of future pension liabilities.

The asset class, which broadly consists of asset‑backed securities (ABS), non‑agency mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and collateralized loan obligations (CLOs), typically provides a meaningful credit spread advantage over corporate bonds with similar credit quality. Although bonds in the asset class are often complex, this complexity can work to an investor's advantage as thorough fundamental research can often uncover attractive opportunities in securitised credit.

While liquidity can be limited in some segments of securitised credit, particularly versus high-grade corporate and government bonds, it is meaningfully better than in some alternative pension fund allocations, such as private credit. Also, book yield-focused investors are generally reluctant to realize gains or losses on their holdings because of unfavourable tax treatment, so they can largely be considered buy and hold investors. This makes them less sensitive to mark-to-market price fluctuations and less focused on returns relative to a benchmark. Because of their longer‑term horizon, they may also be more comfortable holding less-liquid assets.

Typical Spread Premium to Similar‑Quality Corporates

We have found that many investors focusing on book yield have historically had relatively concentrated exposure to corporate credit, both investment grade and high yield. Because of its relative complexity and more limited liquidity, securitised credit generally offers a spread premium to comparable corporate credit, a factor that has historically helped generate relatively attractive risk‑adjusted returns (i.e., Sharpe ratios). The securitised credit asset class also offers diversification benefits for portfolios with large corporate credit exposure because securitised performance is driven by different risk factors, such as consumer and real estate fundamentals, and can diverge from corporate performance at different points of the credit cycle.

Another advantage of securitised credit for some institutional investors is that there are also meaningfully more AAA rated bonds available in securitised credit than in other fixed income asset classes such as corporate bonds, where top-rated issuers are increasingly rare. Regulations require some investors to hold less reserves against these high‑quality securities than against lower‑quality bonds, freeing up assets and reducing their cost of capital.

Focus on Identifying Attractive Book Yield and Robust Fundamentals

T. Rowe Price's focus on deep fundamental research, which seeks to identify credit deterioration ahead of the rating agencies, allows us to concentrate on identifying attractive book yields from securities that have robust fundamental underpinnings. As long as we have a high degree of confidence that a security will mature at par, permitting the investor to capture the full book yield over the life of the investment, we—and more importantly, the end investor—can be somewhat indifferent to day-to-day price fluctuations related to market risk sentiment or liquidity conditions.

 

 

This post was funded by T. Rowe Price

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Key points

  • Securitised credit can be a useful fixed income allocation for institutional investors who focus on book yield or those trying to match future pension liabilities.
  • The asset class typically provides a meaningful credit spread advantage over corporate bonds with similar credit quality, as well as diversification benefits.
  • Building a customized securitised credit portfolio is an iterative process in which we work closely with the client to refine investment guidelines.

i

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