Securitized 2.0

February 26, 2019

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After falling out of favor post Financial Crisis, the securitized market is again in vogue. The latest iteration is decidedly different, with increased transparency, new issuers, and varied collateral types. The sector spans a wide spectrum, from government-backed bonds to structured credit, with seemingly something for everyone. At IR+M, we believe that our experience as bottom-up security selectors helps us uncover opportunities in this highly nuanced sector. Non-traditional securities may provide investors with attractive return and diversification potential.

Variety is the Spice of Life

slice of securitized mkt1The $11 trillion securitized market offers an array of yield profiles, coupon options, and structural protections. Agency mortgages comprise the majority of bonds outstanding; the remainder is distributed across a variety of assets.

Government-backed bonds can provide differentiation. While these securities do not have credit risk, they do have risk related to the timing of cash flows.

We believe that the diversity inherent in the securitized sector is an opportunity. We rely on our extensive experience as bottom-up security selectors to dissect complex structures and reveal value.

More Yield, Less Credit Risk

We see opportunity in government programs that may be new, limited in size, or less-followed. Small Business Administration (SBA) bonds fit this description. The SBA issues bonds that are guaranteed by the US government and typically have a 50 to 100 basis point yield advantage over Treasuries.

We use specified pools to gain exposure to agency mortgages. With specified pools, we analyze both the loan-level and borrower characteristics of the underlying mortgages.  We select pools that have more predictable future cash flows, which mitigate duration volatility during large interest rate swings.

Securitized Chart

Differentiated Credit Risk

We believe that securitized credit bonds can play many roles – either complementing or replacing corporate credit. The credit risk depends on the underlying collateral. For example, non-agency mortgages’ credit risk is related to the housing market. We seek to mitigate that risk by focusing on bonds with high-quality borrowers and solid credit enhancement.

For asset-backed securities, credit risk is derived from the collateral, which may include vehicles, credit cards, or equipment. In these deals, we maintain a senior position, and are further protected by investor-friendly performance and leverage triggers, which may help moderate losses and improve liquidity.

Securitized Chart3

Securitized Chart2

As bottom-up investors, we believe that there is an abundance of opportunities to add value in the Securitized 2.0 marketplace. Depending on the strategy and client preferences, we invest across the securitized spectrum – from high-quality, government-backed bonds to higher yielding asset-backed securities (ABS) and non-agency mortgage-backed securities (MBS). We seek to unearth securities that add yield and improve the convexity profile and diversification of portfolios across our product solutions set. In broadly diversified portfolios, our corporate credit and securitized sector allocations vary based on cross-market, risk-adjusted relative value determinations. For clients who believe that the credit cycle may be nearing its end, or want to “disaggregate the Agg,” a high-quality, best ideas securitized-only portfolio may be an attractive option.

Sources: Bloomberg Barclays, JPMorgan, IR+M analytics, and SIFMA as of 12/31/18.  Seasoned, high-coupon Agency MBS refers to segment of BloomBarc MBS Index with issue date of 2012 or earlier and coupon of 4% or higher. The views contained in this report are those of IR+M and are based on information obtained by IR+M from sources that are believed to be reliable. This report is for informational purposes only and is not intended to provide specific advice, recommendations for, or projected returns of any particular IR+M product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Income Research & Management.

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