The Sleepy World of Structured Credit
Being a long term investor, i.e. old, pre-GFC I used to (only part-jokingly) refer to the “sleepy world of structured credit” when discussing the opportunity set available with potential investors. That description ended pretty swiftly in 2007/8, but over the near 15 years since, I have seen the slow rehabilitation of our sector including, importantly, the end of the high risk derivative type collateral transactions such as the so called “black box” pools backed by CDS contracts and more investor friendly regulation controlling the industry.
From a growing awareness of the longer term impact the war in Ukraine will have on the global economy, to fears of stagflation across developed economies, to the withdrawal of over a decade of Central Bank stimulus, to the spectre of capital flight from emerging markets stressed by a sharp rise in external debt costs; these concerns (and more) suggest a paradigm shift is underway in the business of global investment.
Why is this relevant to our market now? Structured credit transactions are backed by a range of real assets, be they mainstream such as commercial and residential real estate, to niches such as movie rights portfolios. To a greater or lesser extent, real assets have an arguably positive correlation to inflation through a combination of asset value appreciation and an ability to adjust future cashflows e.g. commercial property backed by a long-term lease. Further, the majority of mainstream structured credit transactions in Europe and the UK, and a decent part of the US pool, are floating rate.
In short, the majority of mainstream structured credit should provide some level of natural hedge against current inflation fears and interest rate shocks when compared to a portfolio of fixed rate corporate bonds. Add the fact that debt tranching allows a savvy investor to effectively tailor their risk: return profile, the asset class is in our opinion a sensible diversifier when added to a bond : equity mix portfolio.
Back to being old. The last quarter saw the Bloomberg Global Aggregate Index, a benchmark for government and corporate debt total returns, fall 11% from a high in January 2021, surpassing a 10.8% drawdown during the financial crisis in 2008. Compared to that volatility in a traditionally “safe” area of credit, I may once again be tempted to refer to the “sleepy world of structured credit” when discussing our opportunity set.
by Andy Burgess, Senior Portfolio Manager