The reputation of secured credit investments was badly tarnished by the global financial crisis, and with some justification. Not surprisingly therefore, many investors are asking: is there good reason to venture back?
According to international investment manager Threadneedle Investments (Threadneedle), the answer is a resounding yes.
According to Steven Fleming, Fund Manager in Threadneedle’s Secured Credit Team, today’s secured credit market is a far cry from what was seen pre-2008. Fleming cites the credit quality and strong yields offered by high-quality secured credit investments.
“For investors looking for robust capital preservation while avoiding exposure to long duration risk, secured credit investments can provide significant upside,” Mr Fleming says.
“The positive performance of the asset class is causing some institutional investors to allocate between 5% and 50% to secured credit, and this trend is increasing consistently.
“Interest rates in developed countries are close to zero, with no real improvement in sight.
Consequently, income-seeking investors have turned to asset classes with which they may not be completely familiar,” says Mr Fleming.
“In this case, investors should not automatically be deterred by the chequered history of some secured credit investments. The current market is a very different beast from the one we have dealt with in the past.”
Mr Fleming points out that during the global financial crisis (prompted by the bursting of the US housing bubble and a consequential collapse in liquidity), over 75% of investors in asset-backed securities were highly leveraged (by up to 40 times) and there was no requirement to hold significant capital against their investment portfolios.
“Leveraged investors are no longer involved in the sector, and the risk of a leverage-induced price crash has been eliminated. Yields on secured credit have now adjusted to reflect the investor base and the illiquidity premium and represent real value for investors,” explains Mr Fleming.
“At Threadneedle, our Secured Credit portfolio is typically made up of over 90% of AAA-rated assets, with the remainder AA-rated. We seek secured credit opportunities where the underlying credits are prime residential mortgage loans that have sufficient credit enhancement to ride out any downturn in the market. We avoid American mortgages where non-recourse loans are common, as well as highly leveraged consumers, where the risk of default is much higher.”
Mr Fleming adds that losses on pools of prime residential mortgages have historically been very low and that this should give additional comfort to investors. “In fact, losses have averaged around 0.06% pa over the past 10 years,” he says.
Mr Fleming highlights the fact that the secured credit team at Threadneedle relies on its global experience and detailed analysis of the risk in underlying collateral pools and therefore the quality of underlying loans.
“In the current economic climate, investors searching for income need to look further afield than traditional fixed income asset classes. Those seeking capital preservation may want to consider the new breed of secured credit investments which can offer an attractive risk adjusted return potential,” he concludes.