By Garrett Tripp, Senior Portfolio Manager, CFA
and Toby Giordano, Portfolio Manager, CFA
BRAMSHILL MULTI-STRATEGY INCOME FUND
In a lower-yielding investment universe, an investment in structured credit funds may offer an attractive combination: above-average yield coupled with capital appreciation potential. For Investors and financial advisors seeking a differentiated portfolio, an allocation to structured credit may offer many advantages.
Structured credit funds are composed of bonds backed by pools of residential mortgage loans, consumer loans, or commercial loans. These pools combine loans that individually are illiquid but combined with hundred to thousands of similar loans, become collateral for daily liquid bonds to be purchased by investors. Through this mechanism, credit and competitive pricing becomes more widely available to consumers and businesses.
Because the universe of structured credit is large and varied, funds operate in different parts of the structured credit market. Globally, there was over $4 trillion of structured credit bonds, and $1.1 trillion in structured credit products issued in 2019, according to S&P Global Credit.
THE ABCS OF STRUCTURED CREDIT
Previously, the structured credit market was available primarily to institutional investors who possessed the expertise to evaluate individual pools of assets and match them with their investing objectives. Today, a number of private funds, mutual funds and exchanged traded funds specializing in structured credit are available to individual investors and their advisors.
Because structured credit bonds are available in many maturities and credit qualities, security selection is an important aspect of managing this kind of portfolio.
To create structured credit loan pools, groups of loans with similar characteristics are packaged together. Within residential mortgage loans, for example, the 30-year mortgages of consumers with credit scores between 700 and 750 could be pooled together. Or, 60-month car loans of consumers with credit scores between 650 and 700 would be packaged together
Those pools of loans are then sold into a Trust. The Trust is a legal entity whereby the assets (pools of loans) are held for the benefit of investors. The bonds issued through the Trust are backed by the cash flow—monthly collections of principal and interest—of the pooled loans. These bonds offer a range of coupon, yield, and duration opportunities. Investors have long been attracted to the securities due to the variety of targeted yield and maturity profiles versus the less complex traditional fixed income asset classes. These varied structured credit bond opportunities allow investors to access the credit quality and maturity they desire, in a more targeted way by aligning their investment objectives with bonds they purchase.
THE ADVANTAGES OF STRUCTURED CREDIT
For investors with a traditional stock and bond portfolio, an allocation to structured credit offers diversification. Not only are yields historically low on investment grade bonds, but they also are vulnerable to capital losses in a portfolio should interest rates rise.
Structured credit funds may compliment a traditional allocation by providing incremental yield as well as the potential for capital appreciation. Many structured credit funds purchase floating rate bonds, which have interest rates pegged to benchmark interest rates. A floating rate component further diversifies a structured credit fund because it offers a different interest rate profile than a traditional bond.
Mutual funds that invest in structured credit invest in bonds backed by hundreds or thousands of pools of loans. Each of those loan pools contains hundreds of loans. That means a structured credit mutual fund typically has tens of thousands of different loans within its portfolio, providing a significant amount of geographic diversification. This diversification reduces the credit risk of the fund’s holding because loan performance is historically affected by regional economic conditions.
Managers of structured credit funds can also diversify their portfolios by:
- Type: By residential, commercial or consumer loans and further within these sectors.
- Maturity: By maturity from ultra-short term—under a year—to long-term.
- Credit quality: By credit quality of the borrower whether commercial or consumer.
In the residential mortgage backed securities sector (RMBS), typical investment opportunities include Prime RMBS (larger mortgages to super high quality borrowers), Credit Risk Transfer RMBS (mortgages backed by high quality borrowers and held by Fannie Mae and Freddie Mac), and Non-Qualified Mortgages (mortgages backed by high quality borrowers who typically are self-employed or real estate investors). Other RMBS sectors include bonds backed by the real estate and rents from Single Family Rental (SFR) or Multi-Family Rental properties.
In the commercial real estate space (CMBS), investment opportunities include single-asset, single-borrower (SASB) securities, which are commercial real estate loans taken out by one borrower for one building that are packaged together, and bonds backed by traditional commercial real estate properties, such as office, warehouse, and retail properties.
Non-real estate structured credit assets also come in many categories. In commercial assets, these include franchise loans, equipment leases and aircraft leases. In consumer assets, credit card loans, car loans and leases, solar loans, private student loans and consumer loans all fall under the heading of asset backed securities.
Many structured credit funds invest in bonds that have offered yields in excess of 4 to 5 percent, a significant premium over rates on investment grade government and corporate bonds. With shrewd security selection, fund managers can add value, which may also result in capital appreciation.
For advisors and investors seeking to add a differentiated return stream to portfolios, structured credit may deserve a closer look. The asset classes’ potentially attractive combination of diversification, yield and potential capital appreciation may help many investors achieve their income and growth goals.
THE BRAMSHILL DIFFERENCE
The Bramshill Multi-Strategy Income Fund, sub-advised by Bramshill Capital and advised by Liberty Street Advisors, employs a disciplined and research-intensive strategy using loan-level analysis on the underlying collateral to identify undervalued assets for long-term investment and in shorter-term tactical trading.
In the post-Covid economy, the Bramshill Multi-Strategy Income Fund’s approach has focused on the residential and consumer side of the structured finance market. We believe that many of the protections built into the RMBS and consumer structured credit markets after the financial crisis may offer protection for investors as well. Recent governmental actions, via the CARES act and Federal Reserve, have sought to provide support to homeowners and consumer and related structed credit bonds.
The Fund focuses on a mixed of investment and non-investment grade bonds, many of which may capture capital appreciation as they near their maturity and/or due to potential credit rating upgrades. Tripp and Giordano’s flexible, focused approach seeks to maintain a portfolio yield significantly above competing traditional fixed income total return or corporate investment grade products. They apply significant rigor to portfolio management, regularly evaluating their portfolio to ensure that each pool continues to perform and meet portfolio objectives from a micro (loan level) and macro level (national economic conditions).
ABOUT LIBERTY STREET
The Liberty Street Funds offer investors and financial advisors mutual funds sub-advised by independent boutique managers who possess expertise in their asset class. Because Liberty Street focuses on boutique managers, financial advisors can provide value-added strategies in actively managed and less-correlated portfolios to their clients. Through its selective multi-manager family of funds, Liberty Street provides access to timely investment strategies. The Liberty Street Funds are based in New York City, NY and advised by Liberty Street Advisors, Inc.
For more information about how Liberty Street Advisors may help advisors build timely, value-added and differentiated portfolios, please contact Tim at treick@libertystreetfunds.com or 212-240-9721.
RISKS AND OTHER DISCLOSURES
An investment in the Bramshill Multi-Strategy Income Fund is subject to risk, including the possible loss of principal amount invested and including, but not limited to, the following risks:
Market Turbulence Resulting from COVID-19. The outbreak of COVID-19 has negatively affected the worldwide economy, individual countries, individual companies and the market in general. The future impact of COVID-19 is currently unknown, and it may exacerbate other risks that apply to the Fund.
Valuation: From time to time, the Fund will need to fair-value portfolio securities at prices that differ from third party pricing inputs. This may affect purchase price or redemption proceeds for investors who purchase or redeem Fund shares on days when the Fund is pricing or holding fair-valued securities. Such pricing differences can be significant and can occur quickly during times of market volatility.
Mortgage-backed securities: subject to prepayment risk, “extension risk” (repaid more slowly), credit risk, liquidity, and default risks.
Liquidity: the Fund may not be able to sell some or all of the investments that it holds due to a lack of demand in the marketplace or it may only be able to sell those investments at a loss. Liquid investments may become illiquid or less liquid after purchase by the Fund, Illiquid investments may be harder to value, especially in changing markets.
High Yield (“Junk”) bond: involve greater risk of default, downgrade, or price declines, can be more volatile and less liquid than investment-grade securities.
Sector Focus: focus may present more risks than if broadly diversified.
Fixed income/interest rate: Generally, fixed income securities decrease in value if interest rates rise, and increase in value if interest rates fall. Real estate market: property values may fall due to various economic factors.
Non-diversification: focus in the securities of fewer issuers, which exposes the Fund to greater market risk than if its assets were diversified among a greater number of issuers.
Collateralized Loan Obligations: subject to interest rate, credit, asset manager, legal, regulatory, limited recourse, liquidity, redemption, and reinvestment risks.
Repurchase agreement: may be subject to market and credit risk. Reverse repurchase agreement: risks of leverage and counterparty risk.
Leverage: The use of leverage may magnify the Fund’s gains and losses and make the Fund more volatile.
LIBOR: Many financial instruments use a floating rate based on the London Interbank Offered Rate (“LIBOR”), which is expected to expire by the end of 2021. Any effects of the transition away from LIBOR could result in losses.
Derivatives: derivative instruments (e.g. short sells, options, futures) involve risks different from direct investment in the underlying assets, including possible losses in excess of amount invested or any gain in portfolio positions.