Providing attractive yields while managing risk can be challenging for advisors in the fixed income investments world. Touchstone’s TSEC ETF offers a compelling solution, focusing on high-quality securitized assets with a short-duration approach.
Ricky Schneider, VP and Senior Portfolio Manager at Fort Washington Investment Advisors (a Touchstone Investments Sub-Adviser), shares insights with Wealth Advisor Managing Editor Scott Martin on the Touchstone Securitized Income ETF (ticker: TSEC) strategy, the current state of securitized markets, and how advisors can leverage this ETF in client portfolios.
TSEC’s Unique Approach
TSEC distinguishes itself by concentrating on the short end of the yield curve to maximize yield while limiting volatility. Schneider explains, “We’re not really trying to stretch and hit the home runs every single time out there. A lot of singles and doubles, kind of the middle part of the capital stack.”
This strategy involves targeting securities in the single-A to triple-B range, striking a balance between yield and risk. By focusing on high-quality assets, TSEC aims to deliver competitive yet sustainable yields without venturing into the riskier segments of the market.
The fund’s approach to credit selection is rigorous. “We’ll go down in credit when we find bonds that we really, really like or securities that we like,” Schneider notes. However, he emphasizes that TSEC maintains a diversified portfolio and doesn’t concentrate exclusively on below-investment-grade securities.
Understanding Securitized Assets
For advisors unfamiliar with securitized assets, Schneider breaks down the fund’s focus into four main categories:
- Asset-Backed Securities (ABS): Primarily focused on consumer-related debt;
- Commercial Mortgage-Backed Securities (CMBS): Covering larger commercial properties such as hotels, office buildings, and multifamily complexes;
- Collateralized Loan Obligations (CLOs): Pools of loans to small, medium, and some larger businesses; and
- Residential Mortgage-Backed Securities (RMBS): Concentrating on the nonagency, private-label segment of the market.
By diversifying across these sectors, TSEC aims to capture opportunities in various parts of the securitized market while managing overall portfolio risk.
Commercial Real Estate: Opportunities amid Challenges
Despite widespread concerns about the commercial real estate sector, particularly office spaces, Schneider sees potential. “We think the commercial space is where some of the best opportunities are right now because the whole sector is getting beat up, kind of throwing the baby out with the bath water,” he states.
Schneider acknowledges the challenges facing the office sector as a result of work-from-home trends and company downsizing. However, he points out that high-quality, “trophy” assets in prime locations continue to perform well. This bifurcation in the market creates opportunities for discerning advisors who can identify value amid the broader sector concerns.
The same trend is evident in the retail space, where top-tier malls are thriving while secondary locations struggle. Schneider notes, “Class A malls retailers are doing very, very well.” He also highlights the strong performance of hotels, industrial properties, and multifamily assets.
Impact of Interest Rates
With the potential for lower interest rates on the horizon, Schneider sees a constructive outlook for securitized assets. Lower borrowing costs and compressed risk premiums could benefit both commercial and residential real estate markets.
In the residential market, Schneider points out that high interest rates have suppressed housing turnover. A normalization of rates could reinvigorate the market, he suggests while cautioning that a return to the ultra-low rates of recent years is unlikely. “Something anywhere in the kind of the mid-high 5% would be a much more normalized situation, we think, on the residential side,” he explains.
TSEC’s Investment Process
The fund’s success relies heavily on its rigorous investment process. Schneider emphasizes the importance of both up-front analysis and ongoing due diligence. “We do a lot of work on issuers’ sectors,” he says, detailing how the team evaluates various factors including geographic areas, credit quality, and yield curve positioning.
A key advantage in the securitized space is the availability of monthly performance data. Schneider notes, “You can kind of track is it doing as you’re expected to do, are you seeing prepayments come in where you are? Are credit issues popping up?” This regular flow of information allows the team to actively manage the portfolio and address any emerging risks.
TSEC maintains a relatively short duration of less than three years, focusing on seasoned bonds rather than new issues. This approach allows the team to leverage historical performance data in their credit analyses, potentially avoiding securities that may underperform over time.
Portfolio Application for Advisors
For advisors considering how to incorporate TSEC into client portfolios, Schneider positions the fund as a core fixed income holding. “We kind of think it as a little bit higher yielding but investment-grade strategy,” he explains. TSEC can serve as a replacement for traditional aggregate bond exposure, offering potentially higher yields with less duration risk.
Given the current flat yield curve, Schneider sees particular value in the shorter end of the curve. He advises, “I think you want to pick your spots across the yield curve right now. It’s a good part. Shorter term still looks very good from both a yield and total return perspective.”
For overall fixed income allocation, Schneider recommends a balanced approach with a focus on the five-year and shorter part of the curve. He believes this area offers more opportunistic yields compared to longer-duration, high-quality assets that currently trade at tight spreads.
Outlook on Securitized Markets
Looking ahead, Schneider remains optimistic about the securitized sector, particularly in asset-backed securities. He highlights the growing importance of whole business securitizations, which involve well-known franchise brands. “Your Wendy’s, your Burger Kings. Subway just did a very, very large deal out in the market,” he notes, though he adds that the team carefully evaluates each opportunity based on its merits.
Schneider also points to the expanding role of securitization in the broader financial landscape. As traditional banks potentially reduce their lending activities, he sees the “shadow banking world” of securitization stepping in to fill the gap. Although this trend could create new opportunities for funds such as TSEC, he emphasizes the importance of thorough credit analysis in navigating this evolving market.
Economic Outlook
Regarding the broader economic picture, Schneider leans toward a “soft landing” scenario. He observes that while the bottom 25–30% of the economy may be struggling, higher-income segments remain resilient, supported by a strong job market and accumulated savings from the pandemic period.
“I don’t think we’re going to have a very, very severe recession,” Schneider predicts. He anticipates some moderation in growth but expects consumer spending, particularly on travel and experiences, to continue supporting economic activity.
Key Takeaways for Advisors
The TSEC fund offers a unique approach to fixed income investing, focusing on securitized assets with a strategy designed to balance yield and risk. Key aspects of Touchstone’s investment philosophy and market outlook worth advisor consideration include:
- Short Duration Focus: TSEC’s strategy of targeting short-duration, high-quality securitized assets may offer attractive yields with potentially lower volatility compared to longer-duration fixed income investments.
- Diversified Securitized Exposure: The fund provides access to a broad range of securitized assets, including ABS, CMBS, CLOs, and non-agency RMBS, potentially offering diversification benefits within fixed income allocations.
- Active Management in Securitized Markets: TSEC’s investment process emphasizes ongoing due diligence, leveraging monthly performance data to actively manage risks and identify opportunities.
- Commercial Real Estate Opportunities: Despite broader concerns about the sector, Schneider sees potential in high-quality commercial properties, particularly in prime locations.
- Yield Curve Positioning: Given the current interest rate environment, Schneider recommends focusing on the five-year and shorter part of the yield curve for fixed income allocations.
- Economic Outlook: The team anticipates a soft-landing scenario, with potential for continued consumer spending supporting economic activity.
The Future for TSEC
The Touchstone Securitized Income ETF offers advisors a tool to potentially enhance fixed income returns while managing duration risk in the current market environment. By focusing on high-quality securitized assets and maintaining a short duration profile, TSEC aims to deliver competitive yields with lower volatility compared to traditional aggregate bond strategies.
As the fixed income landscape continues to evolve, strategies such as TSEC that can nimbly navigate various securitized markets may offer valuable diversification and return potential for client portfolios. However, as with any investment, advisors should carefully consider how TSEC aligns with their clients’ risk tolerance, investment objectives, and overall portfolio strategy.
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Additional Resources
- Contact Touchstone Investments ETFs
- Touchstone Securitized Income ETF (TSEC) Overview
- TSEC Summary Prospectus
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Disclosures
Investing involves risk, principal loss is possible.
TSEC Fund Risk:
The Fund invests in fixed-income securities which can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. The Fund invests in mortgage-backed securities and asset-backed securities which are subject to the risks of prepayment, defaults, changing interest rates and at times, the financial condition of the issuer. The Fund invests in investment grade debt securities which may be downgraded by a Nationally Recognized Statistical Rating Organization (NRSRO) to below investment grade status. The Fund invests in non-investment grade debt securities which are considered speculative with respect to the issuers’ ability to make timely payments of interest and principal, may lack liquidity and has had more frequent and larger price changes than other debt securities. The Fund invests in U.S. government securities which are neither issued nor guaranteed by the U.S. Treasury and are not guaranteed against price movements due to changing interest rates.
The Adviser engages a sub-adviser to make investment decisions for the Fund’s portfolio; it may be unable to identify and retain a subadviser who achieves superior investment returns relative to other similar sub-advisers. Events in the U.S. and global financial markets, including actions taken to stimulate or stabilize economic growth may at times result in unusually high market volatility, which could negatively impact Fund performance and cause it to experience illiquidity, shareholder redemptions, or other potentially adverse effects. Financial institutions could suffer losses if interest rates rise or economic conditions deteriorate. The Fund’s service providers are susceptible to cyber security risks that could result in losses to a Fund and its shareholders. Cyber security incidents could affect issuers in which a Fund invests, thereby causing the Fund’s investments to lose value. The Fund invests in Collateralized Loan Obligations (CLOs) that have risks that largely depend on the type of underlying collateral and risks may include illiquidity, limited active market, the possibility that distributions from collateral securities will be insufficient to make interest or other payments, the potential for a decline in the quality of the collateral, and can bear the risk of default by the loans. The Fund invests in foreign securities which carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. The Fund invests in municipal securities which may be affected by uncertainties in the municipal market related to legislation or litigation involving the taxation of municipal securities or the rights of municipal security holders in the event of bankruptcy and may not be able to meet their obligations. The Fund may experience higher portfolio turnover which may lead to increased fund expenses, lower investment returns and higher short-term capital gains taxable to shareholders. The Fund invests in repurchase agreements which are considered loans by the Fund and may suffer a loss of principal and interest in the event of counterparty defaults. Current and future portfolio holdings are subject to change.
Touchstone exchange-traded funds (ETFs) are actively managed and do not seek to replicate a specific index. ETFs are bought and sold through an exchange at the then current market price, not net asset value (NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV when traded on an exchange. Brokerage commissions will reduce returns. There can be no guarantee that an active market for ETFs will develop or be maintained, or that the ETF’s listing will continue or remain unchanged.
Please consider the investment objectives, risks, charges and expenses of the ETF carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one at TouchstoneInvestments.com/resources or call Touchstone at 833.368.7383. Please read the prospectus and/or summary prospectus carefully before investing.
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