Why It May Be Time to Lean Into Securitized Assets

Building a bond portfolio in the current environment presents challenges due to volatile interest rates, tight credit spreads, and significant shifts in US fiscal, trade, and regulatory policies. Securitized assets, such as mortgages and other securitized bonds, offer a promising avenue for diversification, particularly in portfolios balancing interest-rate and credit risk. These assets may provide strategic advantages in response to policy changes under the current administration.

The short-duration nature of certain mortgage debts and collateralized loan obligations (CLOs) can potentially reduce correlation with other fixed-income assets, including government and investment-grade corporate debt. This is crucial as the Federal Reserve's anticipated rate reductions in 2025 may proceed at a slower and more uneven pace than previously expected, with rates potentially settling higher than in recent cycles.

The Federal Reserve's cautious approach is understandable given the economic sensitivity to inflation, compounded by concerns that lower marginal tax rates, tariffs, and reduced immigration might spur growth and elevate prices. Securitized assets offer competitive yields compared to high-yield corporates, with potentially shorter durations, and are particularly appealing given the robustness of US household balance sheets.

Corporate fundamentals, although still solid, show signs of weakening, making securitized assets an attractive alternative. Mortgage-backed securities, including agency mortgage pass-through securities and credit risk transfer securities (CRTs), have demonstrated low correlation with high-yield corporate bonds and other fixed-income categories, enhancing their role in a diversified investment strategy.