A secured finance primer: capturing value by understanding an exploiting complexity | Insight Investment

We believe that secured finance is a greatly underappreciated fixed income asset class. This may be partly due to legacy issues relating to the tribulations of the 2008 global financial crisis. Potential investors may not be aware that defaults have been rare in the secured finance markets. Despite such rarity, secured finance frequently pays a premium over standard corporate bonds of similar and even higher credit ratings, which may be largely because they command a high degree of skill and expertise to properly analyse and model. This represents a exploitable premium for investing in a specialist and complex asset class that is typically less well understood by investors rather than a premium for accepting additional credit risk. Consequently, secured finance could be considered one of the most defensive yet rewarding sources of yield currently available in the fixed income markets.

What is secured finance?

The secured finance market, which includes asset-backed securities (ABS), is a credit market in which the coupons and principal payments are backed by collateral. The investments typically derive their coupons and principal payments directly from underlying pools of loans.

Broadly, three types of collateral are common in the ABS market: residential and consumer, commercial real estate and secured corporate, as illustrated in Figure 1

Figure 1: Three types of secured finance¹

¹For illustrative purposes only. 

Investors also could potentially benefit from other protections beyond collateral assets providing security, such as covenant packages, which are essentially terms and conditions that help lenders manage the risk of default.

The key difference between secured finance and more mainstream corporate bonds is that the latter are typically unsecured (particularly in the investment grade market) and also offer comparatively little in the way of structural protection.

Successfully understanding asset complexity may help capture attractive yield and additional value

It can be challenging for investors to achieve attractive income without migrating up the risk spectrum. We believe secured finance stands out as a compelling option, with higher yields being generally available for a given level of credit risk in what, on close investigation may be considered an asset class that is fundamentally defensive.

At Insight, we have been managing global secured finance portfolios since before the 2008 financial crisis and our portfolios have never suffered a default. We also invest in yet more complex related private secured finance markets across that universe, typically on behalf of our large institutional clients, as those assets may have the potential to achieve further additional yield and returns over time