Securitized bonds: investment potential in a complex market
We think securitized credit may offer attractive risk-adjusted returns, but this complex market requires experienced, in‑depth analysis
- Securitized bonds are complex, requiring a sophisticated investment approach to appropriately assess opportunities and manage risks.
- Expanding the securitized universe “beyond the index” allows for more diversified exposure, reduced volatility and higher risk-adjusted returns.
- Securitized credit may offer more attractive risk-adjusted returns than U.S. Treasuries and investment grade corporate bonds, while helping to diversify risk.
The securitized debt market is one of the largest and most complex bond market segments. That size and complexity offers opportunity, but also creates challenges. Securitized bonds — mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities — must be approached differently than more “traditional” bonds, and they require specialized expertise to uncover value.
In our conversations with investors, we emphasize that security selection will become increasingly important in the coming months and years as new issuance continues to evolve. However, we believe this market may provide an attractive source of alpha for experienced investors — but only if they know where to look.
Nuveen’s scale, breadth and depth of expertise in the securitized sector dates back to the inception of the market in the 1980s. Our disciplined investment process focuses first on the sources of risk as we work to help investors meet their goals.
In this report, we discuss the overall securitized asset class and the nuances of its main subsectors. We give detail about our outlook, investment process and how we uncover value for investors. We also discuss how these asset classes can help investors achieve different goals — we believe that properly managed securitized assets can and should be a part of nearly every investor’s portfolio.
Securitized bonds are structured differently
The securitized sector is generally poorly understood due to its complexity, so it can be helpful to compare the structure of these bonds with those that are more common, such as Treasuries and corporate bonds. These nuances make it critical to rely on the benefits of active management when building a portfolio.
Securitized bonds — mortgage-backed securities (MBS), commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) — differ from traditional bonds in two main areas:
- Underlying collateral. Securitized bonds are generally backed by a pool of loans or other assets, and the payments are usually secured by underlying collateral. The pool typically contains bonds with similar characteristics, such as maturity, interest rate or credit quality. The pool could also be diversified by loan type. Supporting collateral usually consists of an asset such as a car, residential home or commercial property. This backing serves to diversify the risk and return outcomes of individual bonds, as the pool of loans delivers the average outcome over time.
- Repayment schedule. The principal of securitized bonds may be repaid over the life of the security (amortized) or prepaid earlier than expected, rather than returned in a lump sum at maturity.
Additionally, the principal and interest payments from the underlying loans are frequently “structured.” This generally involves directing principal and/or interest payments to designated tranches, or portions, in the series of bonds supported by the pool of loans. These tranches are designed to match maturity and credit rating with investor demand.
A word on risk
Investing involves risk; principal loss is possible. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk and income risk. As interest rates rise, bond prices fall. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. Asset-backed and mortgage-backed securities are subject to additional risks such as prepayment risk, liquidity risk, default risk and adverse economic developments. The value of convertible securities may decline in response to such factors as rising interest rates and fluctuations in the market price of the underlying securities.
1 Data source: Bloomberg, L.P., Bloomberg Barclays U.S. Aggregate Bond Index
2 Data source: Bloomberg, L.P., Bloomberg Barclays MBS Index
3 Data source: Bloomberg, L.P., MBS: Bloomberg Barclays MBS Index; CMBS: Bloomberg Barclays CMBS Index; ABS: Bloomberg Barclays ABS Index
4 Data source: Bloomberg, L.P. Representative indexes: Securitized credit: Bloomberg Barclays U.S. Securitized Index; U.S. Treasuries: Bloomberg Barclays U.S. Treasury Index; Investment grade corporates: Bloomberg Barclays U.S. Investment Grade Corporate Index
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example.
Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A basis point is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001). Call protection is a protective provision of a callable security, prohibiting the issuer from calling back the security for a specified period of time. The period during which the bond is protected is known as the deferment period or the cushion. Correlation is a statistical measure of how two securities move in relation to each other. Perfect positive correlation (a correlation co-efficient of +1) implies that as one security moves the other security will move in lockstep, in the same direction. Alternatively, perfect negative correlation (a correlation co-efficient of -1) means that securities will move by an equal amount in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation; their movements in relation to one another are completely random. Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Standard deviation is a measure of the dispersion of a set of data from its mean. If the data points are farther from the mean, there is higher deviation within the data set. It is used to measure the volatility of an investment. Term premium is the excess yield that investors require to commit to holding a long-term bond instead of a series of shorter-term bonds. An investment waterfall is a method of splitting profits among partners in a transaction that allows for profits to follow an uneven distribution. The waterfall structure can be thought of as a series of pools that fill up with cash flow and then once full, spill over all excess cash flow into additional pools. Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.
Bloomberg Barclays Asset-Backed Securities Index is the ABS component of the U.S. Aggregate index and includes credit and charge cards, autos and utilities. Bloomberg Barclays CMBS ERISA-Eligible Index is the ERISA-eligible component of the Bloomberg Barclays CMBS Index. This index, which includes investment grade securities that are ERISA eligible under the underwriter’s exemption, is the only CMBS sector that is included in the U.S. Aggregate Index. Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value Index measures the stock of debt with yields below zero issued by governments, companies and mortgage providers around the world that are members of the Bloomberg Barclays Global Aggregate Bond Index. Bloomberg Barclays Government-Related Index represents the agency portion of the Bloomberg Barclays U.S. Aggregate Bond Index. Bloomberg Barclays U.S. Agency Index measures agency securities issued by U.S. government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by the U.S. government. Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers. Bloomberg Barclays U.S. Corporate Investment Grade Index is a broad-based benchmark that measures the investment grade, fixed rate, taxable corporate bond market. Bloomberg Barclays U.S. Mortgage-Backed Securities Index covers agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). Bloomberg Barclays U.S. Treasury Index includes public obligations of the U.S. Treasury. Treasury bills are excluded by the maturity constraint but are part of a separate Short Treasury Index. In addition, certain special issues, such as state and local government series bonds (SLGs), as well as U.S. Treasury TIPS, are excluded. STRIPS are excluded from the index because their inclusion would result in double-counting. Bloomberg Barclays U.S. Securitized Index is comprised of predominantly MBS Agency securities, but also includes ABS, CMBS and covered securities. ICE BofA Merrill Lynch U.S. Corporate Index tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market. ICE BofAML U.S. High Yield Constrained Index contains all securities in the ICE BofAML U.S. High Yield Index rated BB+ through B- by S&P (or equivalent as rated by Moody’s or Fitch), but caps issuer exposure at 2%. Index constituents are capitalization-weighted, based on their current amount outstanding, provided the total allocation to an individual issuer does not exceed 2%. Russell 3000® Index includes the 3,000 largest U.S.-traded stocks.
This information represents the opinion of Nuveen, LLC and its investment specialists and is not intended to be a forecast of future events and or guarantee of any future result. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. There is no assurance that an investment will provide positive performance over any period of time.
Nuveen, LLC provides investment advisory solutions through its investment specialists.