Finding Yield in Structured Products

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This interview was recorded on Nov. 4.

My name is Sam Garza. I’m with DoubleLine Capital. I’m a portfolio manager.

As a firm, we are favouring structured products. We have weekly macro meetings where we go through a lot of material, all the portfolio managers, and we look at all of the fixed income markets and we assess what we think is rich or what is cheap. And as we do this analysis, we continue to confront the spread, being pretty tight in U.S. investment-grade bonds. And most of the structured products — structured products being commercial mortgage backed securities, residential mortgage securities, collateralized loan obligations, asset-backed securities — all of the fixed income types that most investors, they’re just really acronyms to them, it’s really the institutional investor space. And those sectors of structured products, to us, look cheaper. We really have been favouring structured products versus corporates. There’s more spread there. And usually there’s less interest rate duration: that’s the potential for bond prices to go down as interest rates go up.

So to explain a little bit further on some of the value that we see in structured products. One of the sectors, for example, is mortgage-backed securities. That’s U.S. residential mortgage-backed securities. If you look at the U.S. economy, the housing market is currently one of the stronger parts of the economy, if not the strongest part. The analysis that it goes into, looking at residential mortgage-backed securities, is usually a bit more detailed. It’s a little bit more complex. That’s an area that we’ve been focused on for quite some time, as a firm. We tend to see a lot of value there, and we’re pretty interested in this sector because it is housing. And also, as I mentioned, investment-grade corporates or corporate bonds in general, we’ve been highlighting as a firm that the U.S. corporate sector is fairly leveraged up. Or, in other words, they part a lot of money. And of course the Fed is backstopping some of that, at least implicitly, the U.S. Fed. And so we like the areas of fixed income that are not specifically the corporate sector, and the housing market tends to be one of those. So that’s a strong, stable market. So we find good value and is not the corporate sector.

Another part of structured products, the market that we like, is CMBS or commercial mortgage-backed securities, very different profile. U.S. commercial real estate is in the midst of a major transition due to the pandemic. Just as an example, hotels, U.S. hotels are trying to deal with much lower occupancy. But the interesting thing about commercial real estate is there are many different sectors you can look at from multi-family or apartment buildings, to retail or malls, to office buildings and to hotels, as I mentioned.

So there’s areas within commercial real estate or within CMBS that we think very opportunistic. And as you look at the structures, there’s a lot of differences in each of the underlying deals. So it really requires a ground-up analysis, but we like the opportunity set in CMBS. It’s different than RMBS. RMBS is more supported by a strong economy. But both of these sectors are outside of U.S. corporate debt. We have the expertise to take a look, and the yields there in general are more attractive than we find in corporate debt. So those are two areas and two examples of why we like structured products versus U.S. corporates.

My current outlook for the balance of 2020 is that there could be some volatility. There’s a couple of reasons for that. One of them is that there’s a significant wave of Covid infections for the rest of 2020. That’s probably something the market will have to deal with. We’re seeing that not only in the U.S. but also in Europe, and that will probably play out over the balance of the year. There may not be stimulus coming. So that’s going to be something the market’s going to have to think about.

On the flip side, and sometime in November or December, it’s very possible that there’ll be information coming on vaccine developments. And I think that could be a very positive development for broader markets. Also, as you move past the U.S. election, that risk moves more into the rear view mirror. And then as you started looking forward to the new year, I think there’s a very large potential for the dynamic to change from what 2020 has been where 2020 has been one very tumultuous year in the U.S. There’s been the pandemic, the global pandemic. There’s been some civil unrest, there’s been an election, and there’s been a lot of market volatility.

So the outlook for the balance of the year is probably a bit more mixed, but I think as you get into the next year, 2021, there’s some interesting things that we want to be thinking about.