“Both pre- and post-COVID results showed that securitized credit ultimately adds value in a fixed-income context,” said Dave Goodson, Voya’s head of securitized credit.
The Voya research found that correlations between securitized credit and the high-yield and bank loan markets had been historically low leading up to the COVID crisis, which Goodson said showed the merits of using securitized credit to increase a fixed-income portfolio’s diversification.
“You add in a tail event, no matter how concentrated — the volatility we saw in securitized credit markets at the peak of market instability in the first quarter was concentrated in a two-week period ― and it can really have a dramatic impact in what those correlations can go to,” he said.
But even as correlations converged in that two-week period, Goodson said investors would have benefited from an allocation to securitized credit. And, given the current dislocation, implementing a securitized credit allocation today has added benefit.
“The space warrants an allocation from a long-term strategic standpoint,” he said, adding, “You can feel good about an allocation now, not only from that long-term strategic perspective ― which is what the study gets into, about optimization over a long period of time — but also on a tactical basis, that today you can take advantage of what appears to be an extremely generous risk-return ratio.”
While securitized credit can play an important role in a portfolio, many investors haven’t seriously considered it in part because of a stigma that stems from the 2008 global financial crisis.
“Securitized was at the heart of that crisis, and it scarred people,” Goodson said. “Even if they didn’t have exposure, they’re thankful that they didn’t have it. That’s continued to color their thinking going forward.”
But the sector has evolved significantly since the financial crisis ― and often outperformed the broader market ― to encompass a similar range of diverse but more heavily regulated opportunities. These include residential mortgage-backed securities, commercial mortgage-backed securities, asset-backed securities and collateralized loan obligations.
Diversity of opportunity
In each of those subsectors, there are opportunities in investment grade, below investment grade and nonrated securities, and in fixed- and floating-rate coupons. These allow investors to customize an allocation strategy across several dimensions that make sense for them.
“There are multiple subsectors,” Goodson says. “Within these and across subsectors you can go up and down the rating spectrum, and you can traverse the entire duration perspective as well.”
That diversity is part of the appeal of securitized credit, allowing investors with different tolerances for risk or volatility to allocate to the sector.
“Sometimes people have a very strong view about certain subsectors, thinking ‘Hey, I’m nervous about collateralized loan obligations or CMBS (commercial mortgage-backed securities), and I don’t want an allocation that might have some exposure there.’ When investors consider an allocation to the sector overall, having this exposure to certain sub-sectors can make implementing it more of a leap. This is why a relative value approach that appreciates that different sub-sectors are at different points in their cycles is so important. Ultimately, in the long run, diversification across the full securitized spectrum is a way to lower your risk.”