Securitized credit: Opportunity amid tight corporate spreads?

Still-elevated yields have made us optimistic about the total return prospects for fixed income investors in the year ahead given a still-positive credit cycle. At the same time, we think it is important to acknowledge that spreads across several sectors are at levels that appear relatively tight compared to historical norms. Yet the rally has been by no means uniform and we observe notable dispersion that we believe creates attractive opportunities for security selection.

Looking across the full range of credit sectors, we see securitized credit as a compelling area of relative opportunity. In our view, this market segment combines appealing risk/reward prospects with potential diversification benefits for active fixed income investors. Moreover, allocations can be customized to meet a range of desired exposures across credit quality, interest-rate risk, and economic drivers. Below we explore the features that highlight the appeal of securitized credit given today’s backdrop of tighter spreads, higher dispersion, and increased volatility risk.

Attractive yields

A long-standing benefit of securitized assets is that they typically offer higher spreads and yields for a given duration than corporate bonds of comparable risk owing to their structural complexity. We think this remains true today, with many securitized products offering higher yields than investment-grade corporate credit, as shown in Figure 1. This yield advantage across securitized markets can potentially mitigate future downside volatility.

Like most credit products, the performance of securitized assets tends to be tied to the health of the economy. The difference is that securitized credit can provide exposure to specific parts of the economy (for example, consumer, housing, commercial real estate) with different performance drivers, thereby potentially reducing correlations with other fixed income sectors. Furthermore, large portions of the securitized credit universe have shorter durations versus other areas of credit, which can act as a hedge to longer-duration holdings in a scenario in which inflation or rates surprise to the upside.

We see opportunities in areas such as:

• Residential mortgage-backed securities (RMBS) and collateralized loan obligations (CLOs) — By sifting carefully through deal terms, we think it is possible to uncover attractive stories within RMBS and CLO segments. We think that RMBS have accumulated enough structural support from embedded home-price appreciation and previous prepayments to withstand meaningful home-price declines, while CLOs benefit from resilient bank-loan fundamentals, supportive demand, robust structures, and a favorable regulatory framework.
• Commercial mortgage-backed securities (CMBS) — These face well-documented structural challenges (notably, working from home and higher interest rates), yet we believe the office sector may be finding a bottom. In our view, the market is pricing in overly pessimistic assumptions just as “green shoots” begin to emerge. What we’re watching closely: the risk of higher yields that could amplify refinancing concerns for already troubled office loans.
• Aircraft asset-backed securities (ABS) — This niche, undervalued sector requires deep, bottom-up diligence on structures and collateral characteristics. We believe structured finance research can help uncover attractive opportunities to be a liquidity provider with these investments.

Structural complexity

It is important to recognize that today’s securitized market is substantially more regulated, with stronger structures, and has vastly stricter underwriting standards compared to those that prevailed prior to the global financial crisis. One notable protection is the natural deleveraging that securitizations experience over time. Underlying collateral pools tend to be amortizing, with principal cash flows paying down senior bonds, deleveraging the structures, and building credit support. We believe the inherent complexity of this asset class also presents potential opportunity for those who have the appropriate tools and the willingness to conduct the deep research required to analyze these securities.

Opportunities to increase exposure as dislocations arise

In our view, securitized credit remains an attractive strategic allocation, benefiting from income at attractive yields and embedded protection provided by the potential for capital appreciation. At this stage of the cycle, we think it is important to remain focused on sector rotation, security selection, and carry while waiting for opportunities to increase exposure. Bouts of volatility — potentially driven by geopolitical/election developments or central bank policy mistakes — could generate greater idiosyncratic dispersion and create attractive entry points to add securitized credit exposure.

Important disclosure

Sources: ICE BAML, JPMorgan CLOIE | JPMorgan information has been obtained from sources believed to be reliable but JP Morgan does not warrant its completeness or accuracy. The index is used with permission. The index may not be copied, used, or distributed without JP Morgan’s prior written approval. Copyright 2024, JPMorgan Chase & Co. All rights reserved. | Source ICE Data Indices, LLC (“ICEDATA”), is used with permission. ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ICE Data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend Wellington Management Company LLP, or any of its products or services. | As of 30 September 2024.