'I don't believe securitized credit spreads are crazy at all if you look at it against governments,' says Robin Marshall
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're exploring fixed income as an asset class and the critical components that make up institutional portfolios.
Securitized credit took a beating during the global financial crisis, when the subprime mortgage meltdown dragged down confidence in anything with the word "securitized" attached to it.
But now nearly two decades later, the asset class has staged a quiet but meaningful recovery. And pension funds are starting to pay attention, according to one expert.
Robin Marshall, director of fixed income research at FTSE Russell, acknowledged how the post-GFC period forced a wholesale rethink of how securitized markets operate. Underwriting standards tightened dramatically after the subprime collapse, and the reckless lending that had defined the pre-crisis era, like self-certified mortgages and minimal income checks was stamped out.
That cleanup laid the groundwork for what Marshall describes as "quite a decent comeback,” noting the catalyst was the post-COVID inflation shock. Most securitized credit deals carry floating rate structures, which meant investors received coupon adjustments as rates climbed.
Contrastingly, fixed coupon bonds were hammered by duration effects.
"Those deals are normally floating rate deals. They don't have fixed coupons, and so you get protection against higher rates and against those powerful duration effects, which basically killed a lot of conventional fixed income bonds and credit," Marshall explained. “The market did very well. It was almost a role reversal compared to GFC, when a lot of the securitized stuff got hit very hard.”
This time, he sees something close to a reversal where residential securitized assets generally performed well, while the weakness was more concentrated in commercial real estate, especially office-linked exposures affected by working from home. Notably, Marshall believes recent market turmoil has exposed how unreliable traditional government bond “safe havens” have become when the stress is inflationary rather than purely growth-related.
He noted that in the latest bout of volatility, 10-year US Treasury yields briefly fell but then snapped back above 4.2 per cent within days as investors refocused on inflation risk, which undermines the idea that bonds automatically protect in stress.
“It's almost as though some of these traditional safe haven characteristics that government bonds have had maybe have changed somewhat,” he said, adding in a stagflation-style shock driven by energy prices, “it's not so obvious that owning a fixed coupon bond is actually going to give you that much protection.”
Another part of his argument is that securitized credit offers diversification benefits. Because the debt is often floating rate, its behaviour is less tied to government bonds than conventional fixed income is. That gives investors a hybrid exposure, Marshall noted as it still sits within fixed income, but it is less vulnerable to rising rates and can keep delivering solid income in a higher-for-longer environment.
Additionally, institutional investors have continued to collect strong coupons in this environment, and the recession that many forecasters predicted when the yield curve inverted never materialized.
"That dog never barked. And as a result, you have done pretty well in these deals," Marshall says.
Marshall also broadens the case by saying credit markets overall are stronger than headline spread levels suggest. In his view, investors looking only at historically tight spreads miss the fact that credit quality has improved since the GFC.
Companies are managing balance sheets more carefully, rating agencies have become more conservative, and some issuers that were once clustered near the bottom of investment grade now look stronger than their ratings implied. That, he suggests, helps explain why credit – including securitized credit – has performed better than many expected.
On mortgage-backed securities specifically, he suggests valuations may still look attractive relative to treasuries because spreads have not compressed the way they have in other parts of credit. He implies that lingering uncertainty around Fannie Mae and Freddie Mac may be one reason for that. Overall, his view is that securitized credit has benefited from floating rate protection, low defaults, improving credit quality, and a market backdrop that has been better than the recession forecasts implied.
Marshall sees a clearer case for inflation-linked government bonds and for securitized credit with floating rate coupons. Inflation-linked bonds tie cash flows to price levels, and floating rate securitized deals adjust income upwards if policy rates rise again, providing a buffer rather than a hit.
He believes these structures are particularly appealing in an environment where energy disruptions can push headline inflation higher, and where the old assumption that treasuries will always rally hard when risk assets sell off no longer holds.
Still, Marshall draws a clear line between what fixed and floating structures do for pension funds trying to manage liabilities.
On one side, he acknowledged fixed coupon bonds make classic asset-liability matching much cleaner because the income profile is locked in, particularly as trustees know exactly pretty much exactly what the cash flow will be throughout the duration of the asset. As a result, they can line those coupons up against known benefit payments and even build bespoke structures of different bonds to generate the required cash flows, he said.
Whereas floating rate securitized credit sits on the other side of that trade-off. Because coupons move with rates, there is more uncertainty about the income stream and therefore "a less, less certain match between your coupon flow and your future cash liabilities," Marshall noted.
Additionally, securitized deals with floating coupons offer what he calls "coupon protection" in a higher-rate environment. According to Marshall, that’s why a sensible pension strategy would tend to have a bit of both - fixed coupons to line up with liabilities, and floating rate securitized credit to guard against the damage from another sharp move higher in yields.
Even with the complication of negative convexity, current conditions make mortgage-backed securities look appealing on a relative value basis. Marshall noted how yields have stayed elevated while MBS (mortgage-backed security) credit spreads have not tightened in line with other parts of the credit market.
"The spreads on MBS actually look very attractive." he said.
He pushes back against commentators calling credit spreads dangerously tight or signaling an imminent bust, underscoring that fundamentals have shifted. After all, Marshall emphasized his first point that improved credit quality, low default rates and policy rates that remain high compared with the post-GFC, pre-Covid period support a different regime.
"I don't believe securitized credit spreads are crazy at all if you look at it against governments,” he said.
