Institutional investors seeking to diversify their fixed income portfolios beyond government bonds and investment-grade credit may find opportunities in securitized credit and capital call financing. The former provides exposure to pools of assets, from consumer loans and mortgages to corporate lending, while the latter offers short-term loans to private market funds backed by investor commitments. For Sid Chhabra of RBC BlueBay Asset Management, both markets offer differentiated sources of credit exposure.
“The traditional institutional investor, particularly in Europe, remains underexposed to securitized credit,” says Chhabra, Head of Securitized Credit, CLO Management and European High Yield. “In a world where sovereign balance sheets are deteriorating and investment-grade credit offers relatively little spread pickup, investors are looking for true diversification and different sources of risk.”
Securitized Credit Offers an Alternative to Traditional Fixed Income
Securitized credit involves pooling loans or other financial assets and structuring their cash flows into tranches with different levels of seniority and risk. According to Chhabra, the combined US, UK and European market is worth nearly $5 trillion, excluding US agency mortgage-backed securities. “It’s not a single asset class, but a multi-trillion-dollar market comprising numerous underlying sub-asset classes,” he explains. “Even within a single segment, such as auto loans, securitizations can differ significantly across the US, UK and European markets. The market is highly diverse and dynamic, with a wide range of structures and underlying assets.”
“It’s not a single asset class, but a multi-trillion-dollar market comprising numerous underlying sub-asset classes. The market is highly diverse and dynamic, with a wide range of structures and underlying assets.”
Sid Chhabra, Head of Securitized Credit, CLO Management and European High Yield at RBC BlueBay Asset Management.
“What’s interesting is that different markets are individually different, so it’s hard to say that one is more or less interesting than another,” Chhabra says. This diversity makes deal-level analysis central to investing in securitized credit. “There’s a rich opportunity set in each of these segments, but capturing them requires a global and diversified team looking across all the transactions.”
“What securitized credit offers, in my view, is true differentiation. You can access more consumer credit and different types of corporate credit, much of it in floating-rate formats, which typically means shorter spread duration and shorter duration overall.”
Sid Chhabra, Head of Securitized Credit, CLO Management and European High Yield at RBC BlueBay Asset Management.
The market has expanded as banks and other originators have increasingly diversified their funding sources rather than retaining it on their balance sheets. For investors, this creates access to sources of credit risk. “What securitized credit offers, in my view, is true differentiation,” Chhabra says. “You can access more consumer credit and different types of corporate credit, much of it in floating-rate formats, which typically means shorter spread duration and shorter duration overall.”
CLO Growth Creates Opportunities Across the Capital Structure
A key segment of this opportunity set is collateralized loan obligations (CLOs), whose growth has closely followed the expansion of the leveraged loan market. “The underlying loan asset class has continued to grow, and over the last five to ten years, it has probably doubled or tripled in size,” Chhabra says. “As a natural consequence, CLO structures have also grown because more managers and credit investors are using them to access the loan market.”
CLOs offer different risk-return profiles across their capital structures. AAA-rated senior tranches appeal to investors seeking higher credit quality, while mezzanine and junior tranches offer greater return potential in exchange for additional risk. “Different investors access the underlying loan asset class in different ways, depending on their risk profile and the return they are looking for to compensate for that risk,” argues Chhabra.
“Different investors access the underlying loan asset class in different ways, depending on their risk profile and the return they are looking for to compensate for that risk.”
Sid Chhabra, Head of Securitized Credit, CLO Management and European High Yield at RBC BlueBay Asset Management.
The steady supply of new CLOs creates opportunities across the capital structure, but RBC BlueBay sees better relative value in some segments than others. The firm currently favors senior, higher-rated tranches, particularly AAA-rated debt. Every CLO transaction must place its AAA tranche, which typically accounts for a substantial share of the deal. “On a relative basis, we like the higher-quality end of the CLO capital structure,” Chhabra says. “In the mezzanine portion, there are a lot of investors, so we think pricing is a little tighter relative to AAA tranches and compared with historical levels.”
“On a relative basis, we like the higher-quality end of the CLO capital structure. In the mezzanine portion, there are a lot of investors, so we think pricing is a little tighter relative to AAA tranches and compared with historical levels.”
Sid Chhabra, Head of Securitized Credit, CLO Management and European High Yield at RBC BlueBay Asset Management.
Lower-rated debt and equity tranches can also offer attractive opportunities, but selection becomes increasingly deal-specific. As investors move down the capital structure, the quality of the underlying loan portfolio and the CLO manager’s ability to select and manage those loans become more important. That selectivity is particularly important in an environment of growing dispersion in credit quality, according to Chhabra. Higher interest rates, energy costs and inflation have put pressure on some borrowers, while lower private equity valuations and upcoming loan maturities have added to the challenges facing certain businesses.
“The biggest trend is simply greater dispersion in credit markets,” Chhabra confirms. “As you move lower down the capital structure, that dispersion matters much more. Understanding which portfolios you like and forming a view on the manager becomes critical.” He believes opportunities remain, provided investors carefully assess the credit quality of individual borrowers, the capabilities of CLO managers and the structure of each transaction.
Capital Call Financing: High-Quality Credit Beyond Traditional Markets
Beyond securitized credit, Chhabra highlights capital call financing as another potential source of fixed income diversification. Private equity, private credit, infrastructure and real estate funds often use revolving credit facilities to cover investment costs before drawing capital from their limited partners (LPs). These facilities are backed by the LPs’ legally binding commitments to provide capital when called. Once the fund calls that capital, the proceeds are used to repay the outstanding loan.
“It’s a credit facility that banks have historically provided to private funds,” Chhabra explains. “Rather than funding an investment immediately through the limited partners, the general partner draws on the facility, with the commitments of those investors standing behind it. The draws are then paid down periodically.”
“[Capital call financing] is a very high-quality asset class, backed by high-quality limited partners, and historically the loss rates have been almost nonexistent.”
Sid Chhabra, Head of Securitized Credit, CLO Management and European High Yield at RBC BlueBay Asset Management.
Although established in private markets, the asset class has received comparatively little direct allocation from institutional investors. Chhabra sees an opportunity to offer investors access to short-term, floating-rate loans backed by capital commitments. “It’s a very high-quality asset class, backed by high-quality limited partners, and historically the loss rates have been almost nonexistent,” he says. “It also tends to be shorter-duration and floating-rate, with draws typically paid down over three, six, nine or twelve months.”
Chhabra estimates that capital call financing can offer a return premium of around 150 to 200 basis points, although actual returns depend on the terms and availability of financing. He views the strategy as a complement to investment-grade credit, offering a different risk profile rather than competing with higher-risk, higher-return strategies. “It’s an excellent complement to the investment-grade part of a portfolio,” Chhabra says. “It is less liquid than investment-grade credit, but it offers a different risk profile and a very low historical loss profile.”
A Growing Market for Portfolio Diversification
Chhabra sees favorable supply-and-demand dynamics in securitized credit, as investors seek to diversify their credit exposures and banks and other originators expand lending. “There’s a better understanding of the need to truly diversify risk exposure,” he says. “Demand is developing in both the US and Europe, creating opportunities for banks and originators to extend more credit. It’s a positive supply-demand dynamic for the asset class.”
“The opportunity is to offer them an investment with a genuinely different risk profile, while providing the underwriting expertise and access needed to invest in it.”
Sid Chhabra, Head of Securitized Credit, CLO Management and European High Yield at RBC BlueBay Asset Management.
Capital call financing, meanwhile, remains an emerging allocation for institutional investors. “It’s a very early stage in terms of the growth of this asset class for institutional investors,” Chhabra says. “The opportunity is to offer them an investment with a genuinely different risk profile, while providing the underwriting expertise and access needed to invest in it.”
For allocators, both markets broaden the range of instruments available beyond traditional fixed income. Securitized credit offers exposure to diverse underlying assets and positions in the capital structure, while capital call financing provides short-term lending backed by institutional commitments. Neither eliminates credit risk, but both offer potential routes to more diversified fixed income portfolios.
This article is part of HedgeNordic’s “Alternative Fixed Income” publication.
