Structured finance portfolio managers are shaking up their fixed-income allocations, choosing to embrace a broader range of strategies beyond traditional benchmarks.
The move is expected to sidestep their limitations and access a wider range of at the Structured Finance Association (SFA), noted that the SEC can take steps to boost public issuance in certain asset classes, such as RMBS, thereby improving visibility in existing indices.
These incremental steps are not enough, however, industry participants said. Larger questions remain about the lack of a comprehensive, structured credit index.
Given this, the SFA announced in February that it would create its own structured credit index on the Bloomberg Terminal. It is now working with Bloomberg to define the asset classes, specific deal categories, and market data that will feed investment opportunities.
Currently, we piece together existing indices
A recent report from Janus Henderson noted that benchmarks such as the Bloomberg U.S. Aggregate Bond Index and the Bloomberg Global Aggregate Bond Index are heavily concentrated in interest-rate risk and exclude significant portions of the investable fixed-income universe. The report also finds that multi-sector fixed-income strategies have historically delivered higher returns and lower volatility than these traditional indices.
The securitization industry recognizes the limitations of current indices, said Dallin Merrill, head of policy at the SFA.
"The bigger question is the lack of an overall credit index—currently, we piece together existing indices," Merrill said. "We look at them; they might be overweight in some areas, and they may not be capturing all CLOs, for example, or the different parts of the RMBS market."
Prime jumbo is different from non-QM, for one example, according to Merrill, with variations according to credit profiles, convexity, correlation and how they relate to other credit products. 00Most individual investors who approached the SFA and are working on its Bloomberg credit index have collaborated before.
"They recognize the value of a third party like Bloomberg, whose business is indices, Merrill said.
The SFA's investor base is wide and deep, all of whom participate in structured credit and securitization in different ways. Their expertise could be useful in helping Bloomberg decide which structured credit the industry could use to benchmark.
"Portfolio managers who are looking at their own performance and allocation could benchmark their performance against an index that truly covers the entire spectrum of structured products and securitization," Merrill said.
But the work is ongoing. The SFA plans to add more asset classes over time.
"We want to create a rules-based, hierarchical taxonomy across structured credit so that we don't have to constantly go under the hood to make manual adjustments to the SFA index," Merrill said.
He added that as structured credit and securitizations evolve they expect to fine-tune and revise the index—especially as they factor in esoteric ABS, data centers, artificial intelligence, and other emerging asset classes, he said.
The Case for CLOs
While the broader CLO market does not have the same level of industry indices as the broadly syndicated loans (BSLs) in which CLOs invest, CLO transaction documentation itself has used index performance as a proxy for certain trigger events for some time, according to Martin Brennan, a partner at Milbank.
For example, credit events governing whether an asset held by a CLO constitutes a "credit risk asset" or a "credit-approved asset" and is subject to the related trading restrictions are determined by reference to indices such as the J.P. Morgan Leveraged Loan Index.
Brennan noted that the J.P. Morgan Collateralized Loan Obligation Index and Palmer Square CLO Senior Indices are the chief market-wide indices providing CLO performance data.
The transparency gap versus the BSL market is otherwise filled by CLO ETFs, and actively managed or passive fixed-income funds that typically invest in specified tranches of a CLO, such as the Janus Henderson AAA CLO ETF, which solely tracks the performance of the highest-rated securities (i.e., the AAA rated notes) issued by a CLO.
An investor ... wants to have as much market information available as possible.
Business Development Companies (BDCs) and closed-end funds, like the Carlyle Credit Income Fund, have also given investors exposure to the blended performance of the riskier (but correspondingly more rewarding) tranches of the CLO: the mezzanine and equity tranches.
"To the extent the BDC or fund is performing well, it's indicative that the CLO securities it has purchased or tracks are performing well," Brennan said. "It is a helpful proxy for a broader market index."
Yet it is still necessarily restricted in oversight to the actual assets the fund or BDC is actually investing in, Brennan noted.
This variety of data offered to investors can only be a good thing, Brennan said.
"An investor, when deciding where to invest money, wants to have as much market information available as possible before," he said.
Historically, CLOs, like other structured products, have lagged behind the broader fixed-income and equity markets in market transparency, but now investors can look at index, BDC, and ETF performance and determine whether the price at which they are investing in a specific CLO security is both fair and the best use of capital.
"With time, the hope is that additional indices come to the fore to enhance the scope of market data, providing greater certainty to investors and, with that, access to new investor bases for the CLO market," Brennan said.
