Modeling Securitized Credit | Voya Investment Management

Modeling Securitized Credit

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Investors looking to assess the potential effects of a securitized credit allocation have limited options given the lack of a widely accepted benchmark or peer universe. Our modeling framework offers an interim solution for optimizing exposure within a higher-yielding multi-asset credit mandate.

Introduction: Why securitized credit needs a custom framework

The challenge

Securitized credit has come a long way since the global financial crisis. Regulation has improved, the technology for structuring deals is observably better, and more types of securities have emerged. As the market has grown and evolved, the opportunity set has become a diverse range of economic sectors, security structures, coupon types and credit ratings, from AAA to below investment grade and nonrated securities.

Yet this very diversity—a.k.a., fragmentation—has posed a significant challenge to index providers, resulting in indexes that have fallen short of fully capturing this market beta. For example, the Bloomberg U.S. Aggregate Index excludes floating-rate securities and any issues not scored by the Big 3 ratings agencies, and size minimums can prohibit entry into the index, leaving the Agg holding mostly agency RMBS. Meanwhile, the J.P. Morgan CLOIE Index and the Vista Credit Risk Transfer indexes only represent single sectors. Furthermore, Morningstar has yet to create a dedicated category for securitized credit funds, lumping them together with dissimilar strategies in either Multisector or Nontraditional bond categories.

We believe the lack of a reliable and reasonably indicative dataset to use in portfolio optimizations has caused investors to consistently underallocate to this dynamic opportunity set.

So we decided to build one. In 2020, we developed an analytical framework that has served as a focal point for countless client conversations, providing an intuitive model in lieu of a standardized benchmark to support allocations to this asset class. Our 2024 report extends the analysis through 2023.

Our approach

  1. Define “securitized credit” in the context of a dedicated allocation, focusing on the four major securitized food groups: commercial mortgage-backed securities, asset-backed securities, non-agency residential mortgage-backed securities (including credit risk transfers) and collateralized loan obligations.
  2. Identify appropriate constituents, starting with securitized credit weighting constraints, then filtering out tourists and category hoppers that might misrepresent the asset class, and finally confirming broad availability. The outcome is a list of 10 constituent funds we can use to create a performance series.
  3. Build a performance series covering 2013 to 2023, using equal-weighted allocations that are rebalanced and reconstituted annually.
  4. Define a base portfolio for optimization based on correlations and risk/return characteristics. This analysis leads us to a 50/50 portfolio of high yield and bank loans as our starting point, against which we optimize securitized credit weights. This approach reflects clear parallels among the three asset classes, often referred to as “plus” sectors and frequently combined as part of a higher-yielding multi-asset (or multi-sector) credit mandate.
  5. Determine strategic allocation bands that maximize the Sharpe ratio, using (1) constrained analysis that optimizes securitized credit against a static base portfolio and (2) unconstrained analysis that allows weightings to vary freely. Both approaches show improved risk-adjusted returns with the addition of securitized credit, owing primarily to lower volatility.

The resulting optimization shows that a 40-55% weight to securitized credit within an allocation to higher-yielding fixed income “enhancers” is a good starting point. An analysis of other fixed income allocations, overlaid with goals and objectives, may influence allocations when trying to build a better fixed income framework for clients.


Index definitions

An investor cannot invest directly in an index, and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations, as volatility and other characteristics may differ from a particular investment. U.S. Agg: The Bloomberg U.S. Aggregate Bond Index is an unmanaged index composed of securities from Bloomberg’s Government/Corporate Bond Index, Mortgage Backed Securities Index and Asset Backed Securities Index; it includes securities that are of investment grade quality or better and have at least one year to maturity. Bank loans: The Morningstar LSTA Leveraged Loan Index is an unmanaged total return index that captures accrued interest, repayments and market value changes. High yield: The Bloomberg High Yield Bond 2% Issuer Cap Index is an unmanaged index that includes all fixed income securities with a maximum quality rating of Ba1, a minimum amount outstanding of $150 million, and at least one year to maturity. MBS: The Bloomberg U.S. Mortgage Backed Securities Index is an unmanaged index composed of fixed-income security mortgage pools sponsored by GNMA, FNMA and FHLMC, including GNMA Graduated Payment Mortgages. Securitized credit: Voya IM securitized credit performance series: Constituents were determined by Voya IM based on a review of funds in the Morningstar Multisector and Nontraditional Bond categories with at least 80% in securitized investments and no more than 15% in corporate investments. Qualitative criteria were used to eliminate funds from the constituent set, including: a) the fund is closed to new investors; b) the current allocation, while meeting the thresholds noted above, likely represented a tactical move into securitized credit within a broader multisector strategy; c) the fund had an outsized concentration in one subsector of securitized credit; and/or d) the fund experienced significant changes over its lifespan across different Morningstar categories such that, while it may accurately be described as a securitized credit fund today, the historical track record was deemed as not representative of an investment in the asset class. Finally, institutional visibility was validated through eVestment analysis by matching each mutual fund with either an institutional strategy or a fund listing. The performance presented is for illustrative purposes only and is based on the net-of-fees performance for the identified share class. The manager universe is based on analysis conducted by Voya IM; other studies could yield a different set of constituents.

Model limitations and risks

While the investment performance presented above does not represent the results of trading actual investor assets, the returns are based on a model portfolio maintained via MorningstarDirect. The changes in the securitized credit model reflect an annual review conducted by Voya IM with constituents added (or removed) at calendar year-end, and allocations are rebalanced to equal weight annually. Documentation available by request. Regardless, model trading does not involve the same risks as those of trading of actual investor assets, so results may differ. Returns presented are net of all fees and transaction expenses at the underlying mutual fund level but gross of any fees that may be applicable to specific investment vehicles utilized to implement the intended investment model.

Past performance does not guarantee future results. This market insight has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.