Summary Highlights
Executive Summary
- Structured credit investments can help augment yield and total return
- Investors can benefit from its complementary risk/return profile relative to traditional fixed income
- Structured credit can help investors address the risk of rising interest rates
- Regulatory changes have mitigated many of the risks that led to the Great Financial Crisis
- Easterly Structured Credit Strategy: The strategy seeks to provide a high-level of risk-adjusted current income and capital appreciation. Capital preservation is a secondary objective.
This primer provides an overview of these areas:
- What is Structured Credit?
- Evolution of Structured Credit
- Features and Potential Benefits
- Key Risks to Investing in Structured Credit
- The Case for Structured Credit in an Uncertain Interest Rate Environment
- Structured Credit vs Corporate Bonds
- Conclusions
What is Structured Credit?
Structured credit investments include non-traditional bonds securitized by specific pools of collateral, such as residential and commercial mortgages, consumer loans or commercial loans. Through a process called securitization, loans with similar characteristics are purchased and pooled in a trust-like entity known as a Special Purpose Vehicle (SPV). The SPV then issues securities backed by the principal and interest cash flows of the collateral pool. These securities exhibit a variety of characteristics in terms of coupon, maturity, price, yield and credit quality. Figure 1 summarizes the major sectors.
Figure 1: Major Structured Credit Sectors
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Evolution of Structured Credit
Since the Global Financial Crisis, the structured credit market has undergone significant changes and enhancements. Numerous regulatory changes, including the Dodd-Frank Act and the Volcker Rule within the United States, and Basel III globally, have resulted in tighter lending standards, increased disclosure and reporting, greater risk retention by originators and increased capital requirements. These changes have led to increased oversight and protections for investors.
Features and Potential Benefits of Structured Credit
Structured credit can benefit investors in several ways, including the potential for relatively high risk-adjusted returns, attractive monthly income, portfolio diversification, and limited exposure to duration and credit risk.
Floating Rate: Many structured credit products offer a “floating” or variable rate. Similar to more commonly known bank loans, the coupon offered is typically a spread above a benchmark rate, such as LIBOR. This can be particularly appealing when interest rates are rising.
Risk-Adjusted Yield Premium: Structured credit typically offers investors attractive yield per unit of duration relative to traditional fixed income (See Figure 2).
Tranched Risk: While the collateral is made up of pools of loans with similar characteristics, structured credit securities are typically tranched into a capital structure through a process known as subordination (See Figure 3). Each tranche is offered separately, and each has a distinct risk/return profile.
The more senior tranches typically have less exposure to credit risk and, as a result, have lower yields. Conversely, the more junior the tranche, generally, the higher the levels of credit risk and yield (See Figure 3). This allows investors a broad spectrum of options to satisfy their risk/reward preferences.
Credit Enhancement: In addition to the subordination described above, structured credit may offer another advantage over traditional fixed income: credit enhancement, through overcollateralization and excess spread. This can help mitigate credit risk and can provide a buffer against loss.
Diversification: Structured credit may offer diversification at both the loan and the portfolio level. At the loan level, structured credit securities are typically collateralized by a diverse pool of similar assets, such as loans. This diversifies the collateral pool, reducing idiosyncratic credit risk of all tranches in the deal. At the portfolio level, investors can gain exposure to a part of the fixed income market that exists outside major indexes and ETFs. In addition, structured credit has historically had low correlation among its sub-sectors as well as to traditional fixed income sectors.
Figure 2: Structured Credit Sectors Provide More Yield Per Unit of Duration
Blue bars represent structured credit sectors and gray bars represent traditional fixed income categories.
Source: Bloomberg, J.P. Morgan, Orange Investment Advisors. As of 09/03/2025. Information shown are daily yield-to-maturity (YTM) and duration statistics for various sectors shown.
CLO is represented by JPM CLO Post Crisis BBB 2-3 Yr Reinvestment; RMBS is represented by JPM Non-QM 2020 BBB; ABS is represented by JPM ABS Auto Loan Subordinate; CMBS is represented by JPM Conduit 2019 Conduit BBB; Treasuries, IG & HY Corporates, Mortgage, Municipals and Aggregate are represented by the Bloomberg Indices. Yield per unit of duration is the fund’s/index yield to maturity divided by the fund’s/index duration.
Key Risks to Investing in Structured Credit
Every investment comes with risks. In fixed income, typical risks include interest rate risk, credit risk, liquidity risk and prepayment risk. Risks specific to structured credit include:
Interest rate risk: Rapid and dramatic shifts in interest rates may affect the value of a structured credit bond. Rate movements may also indirectly affect pre-payment or extension risk, which are essentially the risks of a callable bond being called sooner or later than projected by the investor. A heightened level of interest rate risk due to certain changes in general economic conditions, inflation, and monetary policy, such as interest rate changes by the Federal Reserve. Securities with longer maturities or durations or lower coupons or that make little (or no) interest payments before maturity tend to be more sensitive to interest rate changes.
Credit and credit spread risk: Unlike an Agency bond that is backed by the U.S. Government, credit risk cannot be totally eliminated within non-agency structured credit, particularly in lower-rated, subordinate bonds. Although credit quality may not accurately reflect the true credit risk of an instrument, a change in the credit quality rating of an instrument or an issuer can have a rapid, adverse effect on the instrument’s liquidity, making it more difficult to sell at an advantageous price or time.
Liquidity risk: Structured credit products may trade less frequently than other fixed-income products, making them somewhat less liquid. This is directly related to the fact that they are non-index securities, which also carries the benefit of market inefficiency. This risk can normally be effectively managed by experienced structured credit traders, but nonetheless will increase at times of heightened market volatility, potentially resulting in substantial losses in the event of a forced liquidation. Investments with an active trading market or that the Sub-Adviser otherwise deems liquid could become illiquid before the strategy can exit its positions. The liquidity of the strategy’s assets may change over time.
Complexity risk: While pooling multiple loans helps to diversify idiosyncratic credit risk, the structured credit market is complex and diverse, made up of a variety of deal structures and collateral types that require specialized expertise and resources.
Figure 3: Capital Structure Resulting From Subordination*
| Senior Tranches | ▪ Seek to have higher ratings; investment grade ▪ Last in capital structure to incur losses ▪ Receive principal payments first ▪ Lowest yield in capital structure |
| Mezzanine Tranches | ▪ Subordinate to senior tranches ▪ Typically investment grade; can be slightly below ▪ Absorb losses only after junior tranches are written off ▪ Receive principal sequentially after seniors ▪ Yields between senior and junior tranches |
| Junior Tranches | ▪ Subordinate to mezzanine tranches ▪ Unrated or below investment grade ratings ▪ First in capital structure to incur losses ▪ Last in capital structure to receive principal ▪ Highest yield in capital structure |
*For illustrative purposes only.
The Case for Structured Credit in an Uncertain Interest Rate Environment
With the onset of de-globalization, localized supply chains, bulging fiscal deficits, and challenging demographics, the 40-year decline in yields toward zero has come to an end. Yields at the long end of the Treasury curve, as well as interest rate volatility, have remained elevated since the spike in rates in 2022, with the 10-year Treasury spending over 80% of the time between 3.5% and 4.5% since Q4 2022. In addition to these structural factors that underlie long-term inflationary expectations, the supply-demand technical backdrop for U.S. Treasuries also hinges on foreign demand. Foreign investors currently hold more than 30% of U.S. Treasuries, and any attempt by them to “de-dollarize” their holdings could have profound implications for the U.S. rates market.
Given the multitude of underlying factors, timing the U.S. interest rate market has proven to be an extremely difficult and often fruitless endeavor. Instead, we believe investors should focus on building fixed income portfolios with high yield per unit of effective or spread duration. As shown in Figure 2, structured credit sectors can offer higher yields per unit of duration than traditional Bloomberg Aggregate index sectors. This yield advantage seeks to act as a buffer during periods of elevated interest rate volatility by offsetting price declines stemming from rate increases.
Because of the limited presence of passive investing in structured credit due to the lack of a benchmark index, the market tends to trade more inefficiently, offering the potential for higher risk-adjusted returns. Active management emphasizing security selection can identify opportunities across various structured credit sectors—such as Non-Agency RMBS, CMBS, ABS, and CLOs—which collectively represent over $3 trillion in outstanding market value and offer tremendous diversification and heterogeneity in terms of collateral types, structures, ratings, credit risk, interest rate risk, and average life profiles. During periods of rising interest rates, investors can target floating-rate or shorter duration fixed rate securities, while in steady or declining rate environments, duration can be extended to longer duration fixed rate structured credit bonds.
Another advantage of structured credit is lower correlation with equities, providing greater diversification as the fixed income component of a traditional 60/40 portfolio than traditional Bloomberg Aggregate core strategies. We believe the traditional 60/40 portfolio has become less effective, as demonstrated by the Bloomberg Aggregate Index’s failure to offset equity losses during periods when rates rose by more than 300 basis points over the past four years. Structured credit, in contrast, offers lower correlation to equities than the Aggregate Index, while providing significantly higher yields. As a result, incorporating structured credit into an overall asset allocation can improve a portfolio’s Sharpe and Sortino ratios.
Structured Credit vs Corporate Bonds
From a historical valuation perspective, structured credit spreads are currently around the median based on both a 5-year and 10-year lookback, while both investment grade and high yield corporate bonds are in the first decile in terms of tightness.This suggests that, from a technical perspective, structured credit currently looks more attractive than corporate credit. From a fundamental perspective, the appeal of corporate debt has diminished amid a heightened probability of recession, uncertainties surrounding potential tariff policies under a Trump administration, and possible fiscal retrenchment due to budget constraints. Additionally, corporations face a looming refinancing risk, with over $2 trillion in debt maturing over the next four years. Given higher interest rates and the potential for earnings shortfalls in a recessionary environment, there is a high likelihood of widening credit spreads in the corporate sector. Meanwhile, the residential housing market remains robust, with home prices continuing to rise year-over-year and up more than 10% over the past three years, supporting RMBS valuations. RMBS credit performance has been strong, supported by high levels of embedded homeowner’s equity and robust underwriting standards on the underlying loans, resulting in low delinquency rates.
Today’s RMBS bonds bear little resemblance to those that contributed to the Global Financial Crisis. In fact, structured credit often presents lower credit risk than comparably rated corporate bonds due to diversification, credit enhancement, and structural protections. For instance, structured credit bonds benefit from “self-correcting” mechanisms such as over-collateralization, excess spread, senior/subordinate tranches, interest diversion triggers, and default event protections, all of which shield senior bondholders. Even in sectors facing ongoing challenges—such as CMBS office bonds affected by the post-COVID work-from-home shift and the obsolescence of lower-quality buildings—valuation has adjusted. Cap rates have reached attractive levels, allowing senior CMBS tranches to now offer attractive loss-adjusted yields. Similarly, various esoteric ABS sub-sectors offer investment-grade, short-duration bonds with attractive yields, providing a refuge from perceived macro-related spread volatility.
Conclusions: A Niche Where Expertise Matters
Overall, we see structured credit as an important piece of a diversified portfolio. By including exposure to structured credit within their diversified bond portfolios, investors can potentially increase their overall risk-adjusted yield while including an asset class with low correlations to other market sectors. And in a period of rising rates, structured credit’s risk/return profile can be even more attractive.
Because structured credit is a specialized part of the fixed income market, investors may benefit most from working with an experienced manager who can understand, identify and unlock the value that this market may offer.
Glossary
Average Price: Average price is generated by Morningstar from the categories funds by weighting the average price of each fund’s portfolio by its relative size in the category.
Bloomberg Barclays U.S. Aggregate Index: A broad bond index covering most U.S. traded bonds and some foreign bonds traded in the U.S. The Index consists of approximately 17,000 bonds.
Collateralized Debt Obligations: A CLO is a trust typically collateralized by a pool of loans. A CBO is a trust which is often backed by a diversified pool of high risk, below investment grade fixed income securities. A CDO is a trust backed by other types of assets representing obligations of various parties. For CLOs, CBOs and other CDOs, the cash flows from the trust are split into two or more portions, called tranches.
Effective Duration: This measure of duration takes into account the fact that expected cash flows will fluctuate as interest rates change and is, therefore, a measure of risk. Effective duration can be estimated using modified duration if a bond with embedded options behaves like an option- free bond.
Sharpe Ratio: A measure for calculating risk-adjusted return, it is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.
Sortino Ratio: A variation of the Sharpe ratio that differentiates harmful volatility from total overall volatility by using the asset’s standard deviation of negative portfolio returns, called downside deviation, instead of the total standard deviation of portfolio returns.
Spread Duration: The sensitivity of the price of a security to changes in its credit spread. The credit spread is the difference between the yield of a security and the yield of a benchmark rate, such as a cash interest rate or government bond yield.
Yield per unit of duration: Is the funds yield to maturity divided by the fund’s duration.
YTM: Yield to Maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures. Yield to maturity is considered a long- term bond yield but is expressed as an annual rate.
Important Risks
CLO is a trust typically collateralized by a pool of loans. A CBO is a trust which is often backed by a diversified pool of high risk, below investment grade fixed income securities. A CDO is a trust backed by other types of assets representing obligations of various parties. For CLOs, CBOs and other CDOs, the cash flows from the trust are split into two or more portions, called tranches. Each tranche has an inverse risk-return relationship and varies in risk and yield. The Portfolio may engage in frequent trading of portfolio securities resulting in higher transaction costs, a lower return and increased tax liability. Basis risk refers to, among other things, the lack of the desired or expected correlation between a hedging instrument or strategy and the underlying assets being hedged. Certain derivative and “over-the-counter” (“OTC”) instruments in which the Portfolio may invest, such as OTC swaps and options, are subject to the risk that the other party to a contract will not fulfill its contractual obligations. The issuers of fixed income instruments in which the Portfolio invests may experience financial difficulty and may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Credit spread risk is the risk that credit spreads (i.e., the difference in yield between securities that is due to differences in their credit quality) may increase when the market believes that bonds generally have a greater risk of default. The dollar value of the Portfolio’s foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
Important Investment Risks
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As of 3/31/2025, Easterly Asset Management (“Easterly”) and its Strategic Partners have $60B in managed assets which includes $3B in AUM managed by Easterly’s wholly owned subsidiary, Easterly Investment Partners LLC, a registered investment advisor. Easterly serves as the growth platform for the firm’s asset management business. In 2021, Easterly formed Easterly Clear Ocean (formerly known as Maritime Logistics Equity Partners) to take advantage of opportunities and dislocations in the international shipping markets. In November 2023, Easterly announced a strategic partnership with Lateral Investment Management where Easterly will provide access to its technology, fundraising, and operations expertise, and will invest alongside the firm in certain deals. In March 2024, Easterly announced a strategic partnership with Harrison Street, a leading investment management firm exclusively focused on alternative real assets.
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The material contains information regarding the investment approach described herein and is not a complete description of the investment objectives, risks, policies, guidelines or portfolio management and research that supports this investment approach. Any decision to engage the Firm should be based upon a review of the terms of the prospectus, offering documents or investment management agreement, as applicable, and the specific investment objectives, policies and guidelines that apply under the terms of such agreement. There is no guarantee investment objectives will be met. The investment process may change over time. The characteristics set forth are intended as a general illustration of some of the criteria the strategy team considers in selecting securities for client portfolios. Client portfolios are managed according to mutually agreed upon investment guidelines. No investment strategy or risk management techniques can guarantee returns or eliminate risk in any market environment. All information in this communication has been obtained from sources believed to be reliable but cannot be guaranteed. Investment products are not FDIC insured and may lose value.
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