How structured credit investments can help with diversification

Retail investors seeking diversification through alternative investments may not have considered structured/asset-backed credit, believing it’s only for institutions. But that’s not the case.

While most of the securities in structured credit are issued as 144A instruments, which requires the buyer to be a Qualified Institutional Buyer which owns and invests at least $100 million in securities, individual investors can buy mutual funds or other registered funds that invest in these securities.

But why should they?

InvestmentNews has been speaking with Sam Reid, investment partner at $26.7 billion AUM alternative asset manager Canyon Partners, who says that structured credit, or asset-based lending, generally plays a relatively small part of retail fixed income portfolios today, but they are a large and essential part of the credit ecosystem in this country.

“Structured credit can offer retail investors the chance to diversify their sources of income and potentially increase yields relative to corporate credit, while taking advantage of credit enhancement and structural protections that we believe help mitigate downside risks,” he said.

Often backed by pools of assets such as residential mortgages, HELOCs, or consumer loans, structured credit’s diversification of borrowers within the pools offers less exposure than specific-borrower or corporate bonds to idiosyncratic risks and should also have different fundamental drivers.

These are important considerations for investors who may be cautious about adding something unfamiliar to them into their investment mix. And Reid says that structured credit have several other features that the corporate credit market does not.

“These securities are typically required to deleverage over the life of the securitization, which is in contrast to corporate credit where borrowers can often increase leverage after issuance,” he said. “The transactions usually have static asset pools and static liabilities structures. This means, owners of structured credit know what they own, assets cannot typically be moved out of the trust, and they know where they rank in the structure (which generally cannot change after issuance). In comparison, priorities and collateral can be adjusted in corporate capital structures. Finally, structured credit provides higher levels of amortization that help reduce exposure over time, reducing refinancing risk.”

RISKS FOR INVESTORS?

Higher returns typically come with higher risks; so what does Reid cites as the main risks from investing in structured credit?

“In our view, the excess returns in structured credit typically come from the additional work required to underwrite these securities. Not all credit managers have the experience and analytics to underwrite the dozens of subsectors in the structured credit market,” he said. “Liquidity is another reason for excess yield. While structured credit is generally liquid and trades daily, it is not as liquid as IG corporate bonds and the market requires experience and expertise to navigate. Finally, investors must in part rely on the underwriting standards of the loan originators in making their loans. Since the Great Financial Crisis in 2008, underwriting standards have improved and become more standardized.”

But while structured credit is less liquid than investment-grade corporate bonds, retail investors’ exposure can be via mutual funds offering single day liquidity. 

“Returns are realized through interest collection, amortization, and secondary sales. Very often these securities are structured to allow the investor to recoup 20%+ of its principal investment in the first year of the investment’s life,” explained Reid.

OUTLOOK FOR YEAR AHEAD?

Finally, Sam Reid shared his outlook for the overall credit marketplace in 2025, which he sees as generally positive.

“Consumer balance sheets are in good shape, the job market and wage gains remain healthy, and consumer debt levels are manageable. Delinquencies and defaults for prime consumers are still quite low and we continue to believe structured credit can offer excess yield for investors,” he said.

Even in a downturn, Reid and his Canyon Partners colleagues expect prime homeowners with mortgages to be resilient and significantly outperform other segments such as renters and low-income consumers.

For structured credit, a rapidly growing market, Reid sees potential for it as part of the fixed income markets that the firm believes will outgrow other areas of credit markets.

“The asset-backed securities market experienced record issuance last year as banks and originators are increasingly looking to sell securities to investors instead of keeping them on their balance sheets so that they can be more efficient with their capital,” he said. “Retail investors interested in the space should look to vehicles like mutual funds with experienced managers in the space.”