Resources and Insights

Introduction

Fixed Income has long been regarded as an important component of investment portfolios for its income generation and diversifying potential. Investors often think first of Treasury bonds or Corporate credit when thinking of Fixed income, but the asset class also includes several sub-sectors including Sovereign Debt, Emerging Market Debt, Securitized Products, Corporate Bonds & Loans, and Municipals, among others.

This article aims to articulate the relative value embedded in Securitized Products relative to Corporate bonds in the Fixed Income Universe. Securitized Products (“SP”) references a ~$13Tn+¹ segment of the Fixed Income markets composed of bonds backed by mortgages, consumer debt, corporate loans, rental property income, and numerous other more esoteric cash flow streams.

Relative value comparisons help identify opportunities within Fixed Income where investors can aim to achieve superior risk-adjusted returns. We believe one of the most compelling areas in today’s market is the spread differential between Securitized Products (SP) and Corporate Credit across different rating categories. The data below highlights that SP offers wider spreads than corporate bonds of equivalent credit ratings

Across all rating categories, SP offers a significant spread premium over corporate bonds, with the differential widening at lower rating tiers. This raises the question: Why do Securitized Products assets command such a premium, and does this represent an opportunity for investors?

Key Drivers of Spread Differentials

Several factors contribute to the wider spreads in Securitized Products compared to corporate bonds:

1. Esoteric Collateral: Each deal within the SP sector is backed by a unique pool of assets; while the bonds may appear to have been issued under the same Shelf (akin to a Ticker in the stock market), the underlying set of assets (think mortgages, consumer loans, etc) may have materially different credit scores or other characteristics.
2. Unique Structural Features: These bonds are structured in trusts with cashflow waterfalls that determine the relative credit risk and time to pay off for each security; this “tranching” as it is known, creates significant complexity for those unfamiliar with how to model and evaluate the risks associated with each tranche. Additionally, it is common for the structural features of each deal to vary from one another – call options, performance triggers, waterfall language, and the like can vary meaningfully and impact the relative-value to bond buyers. This obligates buyers to do their own homework on the assets in a market that operates on a “buyer beware” basis.
3. Structural Complexity and Prepayment Risk – Many SP instruments involve structural enhancements like tranching and credit subordination, which can make risk assessment more complex. Additionally, certain types of securitized debt (e.g., mortgage-backed securities) are subject to prepayment risk, introducing cash flow uncertainty that corporate bonds typically do not face.
4. Liquidity Premium – Securitized Products often have smaller class or tranche sizes and each deal is backed by a unique cohort of assets; this means trading in SP requires specialized expertise and can contribute to lower liquidity relative to more homogeneous corporate issuances.
5. Historical Perception and Risk Aversion – The memory of the 2008 financial crisis still weighs on investor sentiment toward Securitized Products. Despite significant improvements in underwriting standards, structural protections, and transparency, some investors continue to require a higher risk premium for SP compared to corporate credit.
6. Regulatory Treatment and Investor Base – Regulatory capital requirements can discourage certain institutional investors from holding securitized debt relative to corporate bonds. Banks and insurance companies often face higher capital charges under frameworks like Basel III and Solvency II, reducing demand for these instruments and keeping spreads elevated.

Why Securitized Products Offer Compelling Relative Value

While wider spreads might suggest higher risk, Securitized Products offer distinct advantages that make them an attractive alternative to corporate bonds:

1. Diversification Benefits – Many Securitized Products are backed by pools of assets such as residential mortgages, auto loans, or commercial real estate, reducing idiosyncratic risk tied to a single issuer’s financial health. These underlying assets, whether loans, mortgages or otherwise, might be secured by hard assets such as a home, building, or car that can be reclaimed in the event of non-payment.  In contrast, corporate bonds depend on the issuing company’s ability to meet its obligations. Some corporate bonds may also be secured, but recent stress events have illustrated how companies can take advantage of “cov-lite” legal documentation to shift away collateral from corporate bond holders.
2. Structural Protections – SP instruments have built-in credit protections, such as bankruptcy remote senior-subordinate structures and cash flow waterfalls, that provide loss protection for more senior tranches. This may make highly rated SP instruments safer than equivalently rated corporate bonds.
3. Enhanced Yield Potential – Given the structural complexities and liquidity premium, investors willing to conduct thorough due diligence can achieve superior yields relative to similarly rated corporate bonds, enhancing overall portfolio returns. Similarly, professional managers can add value through the active management of a portfolio.

Conclusion

The wider spreads available in Securitized Products relative to corporate credit present a strong case for their inclusion in diversified fixed income portfolios. While additional complexity and liquidity concerns warrant consideration, the structural protections and diversification benefits of SP can make these assets a compelling choice for active investors willing and able to dig deeper into their esoteric nature. In a market where returns compression is a constant challenge, SP offers an opportunity to enhance returns without necessarily taking on proportionally higher risk.

Please contact the Asterozoa Management team with questions or for more information.

1. Source: JP Morgan Research, Asterozoa Management ↩︎