Jin Im, associate portfolio manager for the Investment Grade Fixed Income team at Allspring Global Investments, and Rob Absey, head of Insurance Solutions, discuss structured products, often referred to as securitized assets or securitized products, and the value and importance these assets can have in overall investment portfolios. Topics of conversation are ABS (asset-backed securities), CMBS (commercial mortgage-backed securities), CLOs (collateralized loan obligations), and CDOs (collateralized debt obligations).
Jin Im: We’re in a period right now that we haven’t seen in a very long time. There are opportunities across mortgages, agency mortgages. We haven’t really seen this opportunity in 10+ years.
Rob Absey: That’s Jin Im, associate portfolio manager for the Investment Grade Fixed Income team at Allspring Global Investments. I’m Rob Absey, head of Insurance Solutions here at Allspring, and you’re listening to On The Trading Desk®. Today we’re discussing structured products, often referred to as securitized assets or securitized products, and the value and importance these assets can have in overall investment portfolios. Given the large opportunity set, there are investments across the risk spectrum in this sector with the potential to offer an attractive source of total return, yield, stability, and diversification. Thanks for joining and being here today, Jin.
Jin: Great to be here.
Rob: Before we get into it, Jin, and just quickly to level set for those less familiar with the structured products universe and this large sector of the market—by the way, now, it’s almost one-third of the U.S. fixed income market at $12.5 trillion in market value and the second largest after U.S. Treasuries—can you give us a brief idea of what we’re actually talking about and maybe compare and contrast with a more well-known fixed income sector, such as corporate bonds?
Jin: Sure, Rob. So, as you mentioned, the market is around $12.5 trillion. So, the majority of that market is in agency mortgages. So, that’s roughly around $12, $13 trillion. But when we’re talking about other portions of the securitized products market, that includes ABS (asset-backed securities), so ABS is around $800 billion; CMBS (commercial mortgage-backed securities), that’s around $700, $800 billion, as well; and then, CLOs (collateralized loan obligations), also comprises about $1 trillion of the market. So, on top of agency mortgages, we also have ABS, CMBS, and CLOs. So really, when we think about these securities, they’re also backed by collateral. So, they can be backed by mortgages, loans, and leases, and then they can be structured in a way that has a low risk or high risk. So, AAA down to BBB minus. So, they’re really structured in a way that’s a bit different than the unsecured corporate market.
Rob: All right, that’s great background, Jin. Thank you. So, moving on, the Fed (Federal Reserve), as you know, continuing to wage war against inflation, has pushed interest rates in the short 18 months to a 22-year high this week to 5.25% to 5.5%. How has the securitized market weathered this challenge and, related and more broadly, how has this market changed since the Global Financial Crisis in 2008; COVID in 2020; and, even recently, the regional banking crisis here in March of this year?
Jin: Yeah, I’d say first off, it’s certainly a much better market. Certainly, the underwriting has vastly improved when we talk about pre–financial crisis, but the biggest things are the Fed intervention. So, the Fed now has had four rounds of QE (quantitative easing). At one point in time, the Fed owned $2.7 trillion in agency mortgage-backed securities. So, now they roughly own $2.5 trillion. So, think about how many mortgages that the Fed has purchased. But really, in a nutshell, Fed intervention, ultra-low rates, and a lot more regulation. And then the recent regional bank crisis, what we’ve seen is that now the unwind of some of that easy monetary policy, when we think about that crisis, it wasn’t a crisis of credit. In fact, what Silicon Valley Bank and what SBNY (Signature Bank) owned were effectively government-guaranteed securities. In time, those assets would pay full par. But the problem was that given that interest rates—now federal funds is at 5.25%—rose so quickly, the value of the assets that they were holding on their balance sheets declined in value, but over a long enough time frame, they would have been paid back full par on those securities. But they needed to liquidate those securities into a much higher interest rate environment.
Rob: Given all of this and the fact that the Fed may be done or at least close to done with hikes, how is your team here at Allspring employing structured products and securitized assets in portfolios? And how are we sort of set up for the next stage of the cycle? Specifically, what sectors of the structured market do you like? What sectors are sort of not as attractive?
Jin: Really, the biggest opportunity is in agency mortgages. When we talk about agency mortgages, oftentimes we think about what is the mortgage basis? So, what is the spread that you can purchase a mortgage-backed security over the comparable Treasury rate? I often think about what is the inflection point? Maybe it’s 150 basis points. If we think about when QE1 first started happening up to this point in time, how many times has that been above 150 basis points?
Rob: Not much.
Jin: Right. So, since 2009, up until the beginning of 2022, the 2-year and the 5-year have never been above 3.5%. It might have been up a couple days above 3.25%. But we think about, since 2009, we’re talking about the 13 years of time where the 2-year and the 5-year have never been above 3.5%. Now when we take the data currently from the hiking cycle—so, the Fed started hiking in March of 2022 up until now—now, the 2-year and the 5-year had basically been up above 3.5% for about two-thirds of that time. So, call it 200, 250 days or so. Now when we look at the intermediate and the longer end of the curves, as well, and we’re talking about 10- and 30-year rates, if we look back historically, since the financial crisis, the opportunity to purchase anything above a 3.50%, 3.75% percentage rate in the front end, we’ve already established that’s been zero. And then in the long end or in the intermediate end, those days have been few and far between, as well.
Rob: So, agency mortgages are better than they’ve been in the last 15 years.
Jin: Yes. So, agency mortgages, they’ve been more attractive than they’ve been in, call it, the last 15 years. Now, there was a brief period of time during the financial crisis, but then since the Fed has been purchasing mortgages, as I mentioned before, the Fed at one point in time owned $2.7 trillion in agency mortgage-backed securities. They own $2.5 trillion right now. So, that opportunity, the basis during COVID, the basis was somewhere 40, 50, 60 basis points. So, now we’re talking about the mortgage basis being at 150 basis points or more. So, that’s a very attractive opportunity. And we’re also talking about that the curve, really, all points of the curve right now are the most attractive that they’ve been in at least the last decade.
Rob: Yeah. So, is there anything other than mortgage assets or agencies?
Jin: Yeah, so as we’ve established that, the front end of curve, it’s been somewhat uninvestable for the past 13+ years, that the front end has never been above 3.5% since 2009 up until 2022. So, when we look at ABS, ABS typically occupies the shorter duration spectrum. So, when we think about asset-backed securities, the assets underlying that are shorter. They’re auto loans and leases. So, they’re assets with shorter average life profiles. So, those spreads are really attractive at this point in time. During the COVID pandemic, when we saw that front-end rates were zero, the 2-year was somewhere around 25 basis points, 50 basis points somewhere in that range, right? So, and then we were talking about spreads that were 10, 20, 30 basis points. Sometimes it was single digits in basis points. Now we can find those same securities where the front-end 2-year rates are close to 5% now and then, we can get a spread on top of that of anywhere between 50 to even up to 200 basis points on very short weighted asset-backed securities that are AAA rated, as well. So, when we think about credit risk, these are the most risk-averse securities they can buy. In fact, when we look at default rates, historical default rates, no AAA ABS security has taken a loss. So now, by that same token, CLOs. CLOs could have a little bit of a bad reputation because just by, say, guilty by association, that they were a close cousin of CDOs (collateralized debt obligations), which performed very poorly during the financial crisis, CLOs actually never took a loss at AAAs, AAs, and there were only a handful of single-A and BBB securities that they didn’t quite take a loss, but the cash flows were just disrupted. So, when we’re talking about these securities, very safe assets that can yield anywhere between 6% to 7% currently, they’re very attractive assets.
Rob: And what are we avoiding?
Jin: One sector I would say that we’re more cautious on is CMBS. There’s a lot of headwinds in that sector. So, that’s a sector that we’re a bit more cautious on.
Rob: Fair enough. Do you have any parting thoughts for our listeners?
Jin: Yeah, sure. So, I would just say that currently, we’re in a period right now that we haven’t seen in a very long time that really all points along the curve are attractive and investable. So, not only are they attractive and investable, but there’s opportunities across mortgages and agency mortgages that we haven’t really seen this opportunity in 10+ years. And ABS is very attractive, CLOs. CMBS, I would say we’re cautious on, but there’s still opportunities, though. So, it really depends on what your risk profile is. And if you’re not risk averse, then CMBS is a place where you can find a very attractive risk-adjusted return. But it really depends on how much you want to roll up your sleeves and dig into there. But really, the main points are that agency mortgages are very attractive, CLOs, ABS, and really just all along the risk spectrum, up and down the capital structure, as I mentioned. These structures are very robust and they’re built to withstand recession. Those are how these securities are created is what level of the recession are we talking about? Are we talking about financial crisis? Do we think that we’re going to see another financial crisis? Then, we want to stay in the AAA level? Do we think we’re going to see a mild recession? But even risks down to BBB are still prudent in that scenario. So, we’re talking about these securities that are well structured and that are providing attractive opportunities in front-end rates and the longer end of rates and up and down the capital structure.
Rob: Excellent. Well, thank you, Jin. And thank you for being here today and sharing your insights.
Jin: Great to be here, Rob.
Rob: And for our listeners, thank you for joining us here On The Trading Desk®.
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Disclosure: Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.
100 basis points equals 1.00%. The ratings indicated are from Standard & Poor’s, Moody’s Investors Service, and/or Fitch Ratings Ltd. Credit-quality ratings: Credit-quality ratings apply to underlying holdings of the fund and not the fund itself. Standard & Poor’s rates the creditworthiness of bonds from AAA (highest) to D (lowest). Ratings from A to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the rating categories. Moody’s rates the creditworthiness of bonds from Aaa (highest) to C (lowest). Ratings Aa to B may be modified by the addition of a number 1 (highest) to 3 (lowest) to show relative standing within the ratings categories. Fitch rates the creditworthiness of bonds from AAA (highest) to D (lowest).
