Keep it simple

November 22, 2022

Higher base interest rates and wider credit spreads have led absolute yields on fixed income bonds to their highest level in many years. At the same time the fundamental outlook has deteriorated. We would encourage a simple approach in an environment like this – target high quality bonds with low credit risk, whilst still capturing the attractive returns on offer.

Credit spreads in securitized credit have been further driven wider by huge supply volumes in both primary and secondary markets – the latter a hangover from LDI-driven selling by UK pension funds.  In many cases you can now achieve what would traditionally have been viewed as equity like returns in investment grade rated securities. Take a single A-rated CLO for example – a securitization backed by corporate loans. These bonds are credit risk remote and can absorb an extremely large amount of defaults in the underlying pool of loans before taking a principal loss. They currently trade at around 7-8% yield-to-maturity – see chart 1 – are floating rate and also trade at a large discount to par, creating significant upside to an early call.

US A-rated CLO yield

US-A-rated-CLO-yield-chart.jpg

Source: Palmer Square CLO Debt Index. 2017-2022.

Examples like this can be found across the securitized credit markets. The table gives a flavour of types of profiles on offer. Included in the table is also corporate bond yields for comparison, you can see that securitized credit offers even higher yields, for higher ratings and shorter duration (which should result in lower volatility) – this is largely due to the unique technical pressure from supply that the market is experiencing.

Asset class Rating Yield-to-maturity (USD) Spread duration
Commercial mortgage securitization A 8.6% 3.4 yrs
Residential mortgages securitization A 7.5% 2.6 yrs
Corporate loan securitization A 7.3% 6.1 yrs
Commercial mortgage securitization BBB 10.5% 5.0 yrs
Residential mortgages securitization BBB 8.0% 4.8 yrs
Corporate loan securitization BBB 9.0% 6.7 yrs
US Corporate A 5.3% 6.8 yrs
EU Corporate A 5.1% 5.2 yrs
US Corporate BBB 5.8% 6.9 yrs
EU Corporate BBB 5.7% 5.2 yrs

In conclusion, in today’s market investors can target high quality bonds that will protect against fundamental deterioration, whilst achieving very attractive returns.

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