As institutional investors in Asia seek out new means of gaining yield, they are increasingly turning off the beaten path and into other areas. In the fixed income arena, this has led them to turn increasingly to securitised bonds and trade finance.
In the securitisation space, the appeal is the level of return versus the risks. While returns often average from the mid single digits to over 10%, default rates in higher credit tranches in particular are negligible.
Securitisations involve special purpose vehicles (typically created by banks), which use proceeds from bond that they sell to investors to buy loan books of a particular kind. The instruments usually offer decent yields versus public bonds and—if structured well—have relatively low rates of default. The most common are commercial or residential mortgage-backed securities.
The collapse of US subprime mortgage securitisations in the global financial crisis of 2008 tarred their image—particularly that of collateralised debt obligations—but they have been rehabilitated, courtesy of more conservative assessments, higher rates of over-collateralisation and regulatory rigor. Residential mortgage-backed securities offer some of the easiest entry opportunity.
“People see the residential securitisation market as relatively cheap and believe the banks’ provision of debt to residential borrowers is still a bit broken. That’s down to a regulatory overshoot to avoid the problems of pre-crisis,” Chris Redmond of Willis Towers Watson told AsianInvestor.
Korea’s Public Officials Benefit Association has gone more niche. In August it invested just under $20 million with Willis Lease Finance Corporation into securitisation products backed by aircraft engine leases.
“It’s unusual but it looks quite stable and the global lease financing corporations share their risk with the [limited partners],” said Dong-hun Jang, the fund’s chief investment officer.
Trade finance attraction
Trade finance is also gaining attention. Most trade relies on letters of credit (LoC), essentially agreements between the banks of a buyer and seller to transfer payment for an order after a short period—often 90 days.
LoCs are short-dated, reliable and have very low default and interest rate risk, according to expert fund managers who manage them. Kristofer Tremaine, founder and CEO of Tremaine Capital, is one.
“The most compelling space in these loans is in the sub-investment grade [small and medium-sized enterprise] space,” he said, but he noted that gross returns of 8% to 12% yields are possible for loans from ‘A’ or ‘BBB’ rated companies.
However, that might be misleading given the need of such managers to work with banks to compile portfolios of loans. That can eat into net returns. “There are some issues around the vetting scale and ensuring there are not too many agents in the chain taking their cut,” Redmond said. “In theory it’s attractive, but implementation is harder than it sounds.”