Securitized bonds are an area of the investment universe that many investors are not familiar with. The lack of familiarity is understandable. They don’t have issuers that are easy identifiable (e.g. Microsoft or Johnson and Johnson), and are not issued by a government (e.g. United States Treasury Bill, United Kingdom Gilts, German Bunds, etc.) or a state/local municipality (e.g. City of Pittsburgh or State or Pennsylvania).
What They Are and How They Work
Taking a step back, securitized bonds fall under the fixed income asset classification of the investment cosmos; we emphasize cosmos1 here because there is wide space between a U.S. Treasury Bill and a Non-Agency Residential Mortgage-Backed Security (more on that later). Securitized bonds are comparable to a traditional bond in that one party is lending to another, but they differ in many ways. Among them those differences are:
- The way interest payments are made
- What is backing the creditworthiness of the bond
- The duration (interest rate sensitivity
If I have kept you engaged this far, you might be asking… well what is a securitized bond? In a nutshell, a securitized bond is the product of taking many individual financial assets (e.g. individual mortgage loans) and putting them together (in investment parlance, it is called pooling) to create a “bond” that pays investors one interest payment. The source of the payment isn’t from one entity (e.g. United States or Microsoft), but many (e.g. the mortgage payments of me and the rest of my SDMWA colleagues). The process of pooling financial assets is primarily done because it is easier to trade (think find an investor). For example, it would be hard to find someone interested in buying my mortgage loan, but if you packaged my loan with a series of other mortgage loans that mirrored mine across a litany of characteristics2, that would be attractive to buyers. Securitization most often occurs with loans and other assets that generate receivables such as different types of consumer or commercial debt. The most popular securitized products are mortgage-backed securities, who were pioneered by Lewis Ranieri, a prominent Bear Stearns trader.3
How They Can Add Value
Now that we have given you the broad outlines of what a securitized bond is, I want to talk about how it can add value to a portfolio/fixed income allocation. The securitized asset space is vast in size; it is over $2.5 trillion larger than the corporate credit market. However, despite being such a big market, many securitized bonds are not included in the popular fixed income indices like the U.S. Bloomberg (nee Barclays) Aggregate Index. The lack of inclusion in broad indexes, in our opinion, creates the opportunity to add diversification and higher income/return streams into fixed-income portfolios. Despite having unique features such as credit enhancements, income streams that are floating rate in nature, and structures that allow an investor to select the type of risk (and by extension, the type of yield) they want to take, securitized bonds often receive credit ratings that understate their credit quality. The lack of ability to properly rate these bonds can be attributed to the vastness of the investable universe, the complexity of the cash flows, and the structure of the securitized bond; all of these reasons contribute to securitized bonds offering attractive yields for investors with mostly less interest rate sensitivity to a comparably-rated corporate or municipal bond.
Securitized bonds have complexity to them; we don’t want to pretend that they don’t, nor do we think that we can explain them in less than 750 words. However, our investment team believes they have the ability to offer diversification, increased yield, and differentiated return streams when compared to more traditional fixed-income allocations. They don’t have the panache of stocks like Nvidia or Microsoft, the name recognition of U.S. treasuries, or the ubiquity on Twitter that GameStop or AMC enjoy. Instead, securitized bonds operate off to the side, visible to almost anyone willing to look their way, but unable to generate the attention we feel they deserve.
For more information on how we use securitized bonds as a part of our fixed income allocation, please contact me or another member of the SDWMA team. We would welcome the opportunity to have a conversation.
1 Cosmos are really, really, really big.
2 Mortgage loan characteristics would be: down payment size, W2 income of the borrower, location of the house, strength of the local schools, etc.
3 https://www.investopedia.com/terms/l/lewis_ranieri.asp#:~:text=Lewis%20Ranieri%20is%20considered%20by,the%20mortgage%2Dbacked%20securities%20market
About Schneider Wealth Management
Schneider Downs Wealth Management has been providing investment and retirement services since 2000. Although our service platforms continue to evolve, commitment to our clients remains our first priority. Our service is tailored to your individualized goals but built on the fundamental principles of our practice: fiduciary guidance, fee transparency and goal-based decision-making.
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Schneider Downs Wealth Management Advisors, LP (SDWMA) is a registered investment adviser with the U.S. Securities and Exchange Commission (SEC). SDWMA provides fee-based investment management services and financial planning services, along with fee-based retirement advisory and consulting services. Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice. Registration with the SEC does not imply any level of skill or training.
