Times are relatively tough for fixed-income managers. Geopolitical uncertainty, ultralow or negative yields around the world, and the decade-long recovery have resulted in rich valuations in several areas, including corporate credit. As a result, some managers in the intermediate core bond and intermediate core-plus bond Morningstar Categories have relied more heavily on securitized debt over investment-grade and/or high-yield corporates because they believe its various components offer some combination of favorable risk-adjusted returns, good diversification, and ample liquidity. But, like corporate credit, securitized assets are highly correlated to the underlying economy. A change in economic fundamentals can put the sector under pressure, especially for those funds that invest in lower-rated deals. Areas such as credit risk transfers, subprime auto loans, and high-yield collateralized loan obligations are among the most sensitive to changes in the broader economy, all of which are present, in some capacity, within the intermediate core-plus bond category.
The plain-vanilla side of securitized holdings is nothing new. Core bond funds have long invested in agency mortgage-backed securities. The Bloomberg Barclays U.S. Aggregate Bond Index's stake in agency mortgages is just below 28%. Some managers prefer low-risk mortgages for the liquidity benefit and slight yield advantage over U.S. Treasuries. Others, typically in the intermediate core-plus bond group, can be a bit bolder in their securitized exposure.
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Alfonzo Bruno does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.