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Insurers generally take a narrow approach to investing in the securitized sector, usually through allocations in their investment grade fixed income reserve portfolios. In the current environment, with income opportunities constrained, we believe insurers should consider broadening their securitized investment strategy to take advantage of potential income and relative value opportunities in the sector.
Selecting risk preferences
Securitized investors can identify the risk levels where they are comfortable. Within the securitized asset class, the tranching of risk can help enable investors to invest based on their risk tolerance, while having the opportunity to earn a potentially attractive rate of return. Another feature of securitized credit investing can be the diversification it offers into areas like consumer credit and real estate.
The tranching of risk creates a large investable universe for insurance companies seeking investment-grade exposure. In fact, the below-investment grade category currently represents only 5% to 10% of the securitization market. Frequently, higher-rated tranches represent a significant proportion of deal structures with limited availability of subordinated tranches. As an example during the fourth quarter, a prime auto deal’s AAA-rated tranche represented approximately 96% of the deal structure and the remaining tranches were rated AA, A and BBB. Similarly, a new subprime auto deal consisted of a AAA tranche (63% of the deal structure) with the remainder of the notes split amongst AA (9%), A (11%), BBB (9%), BB (4%) and B (4%) rated tranches. We acknowledge that obtaining an allocation to the subordinated tranches (AA+ to BBB-) can be challenging due to their limited supply. However, we believe investing in less liquid, privately sourced structured credit, backed by real assets, can help achieve insurance companies’ targeted allocations.
Accessing securitized markets
Government-sponsored entities, other regulated institutions and independent finance companies rely on the securitization market to finance their operations. The result is a complex and fragmented securitized bond market with approximately 40 times more CUSIPs than that of the US corporate bond market. Barriers to investor participation are high and, in our view, can contribute to securitized spreads being wider than comparably-rated corporate securities.
Caveat emptor: Owning securitized credit is a structurally leveraged bet on underlying fundamentals. Therefore, understanding the macro environment and what is happening within specific sectors are key components to any investment decision.
Additionally, structural leverage can create downgrade risk and binary investment outcomes, particularly in relatively thin classes deep in the capital structure. Analytical sophistication and experience are required in this market. In our view, investors must have scale and relationships with issuers, the sell-side, advisors, and others to originate, analyze, and monitor investments.
We believe that an expanded allocation to securitized credit could benefit insurers. The combination of illiquidity and structural premiums that can be found in the structured credit market can create effective sources of incremental yield potential to support an insurer’s overall business.
WRITTEN BY:
Market conditions are extremely fluid and change frequently.
Any investment that has the possibility for profits also has the possibility of losses.
Diversification does not ensure a profit or guarantee against a loss.
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This blog post is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This material cannot be copied, reproduced or redistributed without authorization. This information is subject to change at any time without notice. Market conditions are extremely fluid and change frequently.
