What drives returns in secured finance?

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Considering that secured finance assets can offer a credit spread premium over corporate bonds despite equivalent credit risks, investors may wonder what drives this additional yield. In our view there are two factors:

1) The complexity premium. This reflects the fact that a high level of expertise is necessary across a range of specialisms - such as legal, accounting and portfolio management - as well as access to a broad network of market relationships. Unlike the corporate bond market, where investors can lean on credit ratings and a swathe of public information, the secured finance market is only open to adequately skilled investors, resulting in lower eligible demand.

2) The illiquidity premium. This represents an additional return that investors require for having their capital tied up. Private credit markets are emerging areas of fixed income with no functioning secondary market. Therefore, a number of secured finance assets need to be held until maturity. As such, investors demand additional compensation for risks.

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