Defined Benefit
Insurance Assets

Rising Interest Rates Spur Look at Structured Credit

Rising Interest Rates Spur Look at Structured Credit
3 min 37 sec

This blog post is based on comments Nate made in an interview with FIN News for this article: Rising Structured Credit Allocations Raise Need For Expertise.

Structured credit, which refers to fixed income investment securities that finance portfolios of income-generating assets, has seen increased interest from institutional investors as they explore ways to adapt their fixed income portfolios for an expected environment of rising rates.

Structured credit vehicles can serve as very effective diversifiers within a fixed income allocation. And there are a number of different directions that investors can take within structured credit to fit different risk profiles in terms of diversification.

Real estate structured credit products such as commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS) are seeing some positive trends, specifically with non-qualified mortgage loans and non-agency RMBS. These are benefiting from rebounds in the housing market and housing prices generally over the past several years, a trend that has continued despite the pandemic. Commercial real estate experienced a dramatic and negative impact caused by the pandemic, but it has found more support recently.

Since structured credit includes varying types of securities and sub-asset classes, it can be utilized to achieve varying objectives. An investor can choose to invest in the senior part of the capital structure, taking less risk with commensurately less yield. Other investors seeking to diversify a high-quality fixed-income portfolio and reaching for incrementally higher yield may find opportunity in lower parts of the capital structure within different securities.

The typical floating-rate nature of structured credit is an additional strength. While many RMBS will be fixed, most collateralized loan obligations (CLOs) and certain CMBS have floating rate exposure. To the extent that rates start to rise and continue to increase, we expect to see a bit more demand for floating-rate securities that are not as impacted by the rising rate environment, or at least will stand to benefit from some of the increase in rates.

What to Look for in Structured Credit Managers

To assess structured credit managers, institutional investors should know how managers source and analyze opportunities. It is important to understand that investing in structured credit is not a skillset that can be developed organically in a short period of time. Investors may consider giving their existing managers expanded guidelines to allow them to invest in these securities if they are willing to take that risk and they believe their managers possess the capability to source and manage structured credit. If not, investors should look for managers that have a proven track record of investing in this space and provide them the flexibility to take advantage of opportunities outside the benchmark where exposures are potentially less correlated with the broader market.

Doing the appropriate diligence is critical given the difficulty in sourcing opportunities. It requires expertise in different areas of the market, such as aircraft leasing, commercial real estate, non-qualified mortgages, or CLOs. These are all very different, unique asset classes even though all are structured credit securities. But at the underlying collateral level, they possess very different risk characteristics. The priority should be to make sure to find the right asset management firm and/or team that has the relevant experience and resources to manage the mandate well.

It is also important to understand the limits of the lower correlation benefits with structured credit as investors are ultimately exposed to the underlying cash flows. A franchise restaurant, for example, may not be immune to an economic slowdown and could be challenged in this type of environment. While the correlations historically have been lower for structured credit, that will not always be the case.

Many structured credit securities performed well amid the Global Financial Crisis (GFC) and continued to show strong returns afterward, despite the large amount of corporate credit exposure within securitized loans. Correlation risk with these securities exists, but they have exhibited resilient performance during recent crises.

Institutional investors that want to allocate to this space should also be aware of other implementation challenges. Investing directly in this asset class may make it more difficult to rebalance the total fixed income portfolio, monitor it, and make sure it has the desired exposures to the various sub-asset classes such as Treasuries and other government securities, mortgages, and corporate credit. Overseeing all of these weights and allocations becomes difficult if the investor does not have the appropriate systems and oversight to make sure all of the exposures are at their projected targets.

Posted by

Share on facebook
Share on twitter
Share on linkedin
Related Posts
Defined Benefit

Alignment of Interests: Best Practices to Make Sure Investors and Their Managers Are in Sync

Jan Mende
Jan Mende discusses how institutional investors can make sure their interests are aligned with their private markets investment managers.
Defined Benefit

Investing in Data Centers: The Real Assets of the Digital Age

Lauren Sertich
Lauren Sertich provides a summary of her recent paper on investing in data centers.
Defined Benefit

Hedge Fund Strategies: A Guide for Institutional Investors

Joe McGuane
Joe McGuane describes the key attributes of hedge funds and how institutional investors should evaluate them.
Defined Benefit

SEC Proposes Rule to Enhance ESG Disclosures for Investments for Funds and Advisers

Kristin Bradbury
The proposal is designed to help investors assess the degree to which ESG considerations are a part of a strategy.
Defined Benefit

Where Do Private Equity Investors Go From Here?

Gary Robertson
Gary Robertson analyzes private equity activity through all the stages of the investment cycle, from fundraising to exits and returns.
Defined Benefit

Unprecedented Territory—and the Inherent Limits of Diversification

Jay Kloepfer
Jay Kloepfer discusses the concurrent declines in the equities and fixed income markets at the beginning of 2022.
Defined Benefit

Geopolitical Upheaval and Unsettled Markets

Jay Kloepfer
Jay Kloepfer analyzes the U.S. and global economies at the start of the year amid geopolitical upheaval and market volatility.
Defined Benefit

Private Credit Appeals to Investors in a Low-Yield Environment

Catherine Beard
Catherine Beard analyzes private credit trends for 2021 and the start of 2022.
Defined Benefit

Market Volatility Tests Hedge Fund Managers

Joe McGuane
Joe McGuane analyzes hedge fund and MAC performance in 1Q22 amid the volatile market environment.
Defined Benefit

Continued Strong Performance Across Real Assets

Munir Iman
Munir Iman analyzes real estate and real assets performance in 1Q22.

Callan Family Office

You are now leaving Callan LLC’s website and going to Callan Family Office’s website. Callan Family Office is not affiliated with Callan LLC.  Callan LLC has licensed the Callan® trademark to Callan Family Office for use in providing investment advisory services to ultra-high net worth clients, family foundations, and endowments. Callan Family Office and Callan LLC are independent, unaffiliated investment advisory firms separately registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940.

Callan LLC is not responsible for the services and content on Callan Family Office’s website. Inclusion of this link does not constitute or imply an endorsement, sponsorship, or recommendation by Callan LLC of their website, or its contents, and Callan LLC is not responsible or liable for your use of it. When visiting their website, you are subject to Callan Family Office’s terms of use and privacy policies.