2022 has been a challenging year for many investors. With STOXX Europe 600 down 22%, S&P 500 down 23%, Barclays Euro Aggregate down 16% and Barclays US Aggregate down 15%, many traditional portfolios will likely be down for the year [1]. AQR argues that even after the decrease in 2022, the outlook of a 60/40 portfolio remains unattractive [2]. Inflation poses a challenge to traditional portfolios. Stocks prices tend to decrease during inflationary periods. Simultaneously, positive inflation news reduces the value of bonds’ nominal cash flows, resulting in lower prices and a positive stock-bond correlation [3]. BNP Paribas AM adds that there have been high stock-bond correlations in previous periods when returns where positive for stocks and bonds. Now that returns are negative for both such correlations are distressing for 60/40 investors [4].

While the performance of public asset classes is easy to observe, this is different for private asset classes. LoanClear’s Dutch Mortgage Index provides insights in the performance of the Dutch Mortgage asset class. Not surprisingly, mortgage investments have suffered losses due to increased market rates in 2022 as well. Nevertheless, a longer sample period shows that Dutch mortgages are an attractive asset class.

The traditional investment portfolio consists of 60% stocks and 40% bonds. Pension funds and other institutional investors have increased their exposure to alternative assets over the last decades which increased diversification benefits. Pension funds and institutional investors typically have a long-term investment horizon, which allows them to better absorb short-term risks that alternative assets generate [5].

Asset class performance

In this article, we compare the performance of the Dutch Mortgage market with other European asset classes. As a proxy for the Dutch Mortgage market, LoanClear’s market weighted Dutch Mortgage Index is used. Offer data from HDN is used to determine the market weight of each segment. To asses asset class performance, loan level mortgage data is used from European DataWarehouse (EDW), which consists of ECB eligible RMBS deals. Additionally anonymized data from LoanClear’s clients is used. To create an investable strategy 10 million Euro is invested each quarter in newly originated loans.

Figure 1 shows the performance of investable strategies that allocate 10 million Euro at the beginning of each quarter in a selection of European asset class indices from 2016-Q1 up to 2022-Q2. The results highlight the advantage of the Dutch Mortgage asset class, attractive returns with relatively low risk. For a large part of the sample period, the cumulative return on investment is among the highest for mortgages, eventually being taken over by the more volatile equities since 2021-Q2. The outstanding performance of the mortgage investment strategy is also visible when looking at the drawdowns as shown in figure 2. Particularly during the covid crash, the performance of mortgages stands out. Whereas the equities and REITs strategies dropped more than 25% from their high in 2019-Q4, the mortgage strategy only dropped 1.08%.

Table 1 shows the average annualized returns and standard deviations of the asset classes during the sample period. The mortgage strategy is superior to the other fixed income strategies, it offers higher returns with a comparable volatility as Government Bonds and Investment Grade bonds and higher returns and lower volatility than High Yield bonds. One factor that drives the outperformance of mortgages over Government Debt is the spread. Furthermore, the mortgage portfolio has a duration of 7.05, compared to 4.75 Investment Grade credit as of 2022-Q2. A higher duration results in more value appreciation in a decreasing rate environment. Vice versa, during 2022, the mortgage strategy lost more value compared to Government debt and Investment Grade credit because of rate increases. Furthermore, mortgage rates tend to move more sluggish compared to rates of more liquid assets.

Portfolio diversification

Table 2 shows the correlation matrix between returns of the asset classes. A lower correlation means more diversification benefits in a multi-asset portfolio. Next to good standalone risk-return characteristics, Mortgages offer great diversification benefits when added to a portfolio with other asset classes. Mortgages offer annualized returns of 1.52% in the sample period, whereas government bonds yielded an average annual return of -1.21%.

The advantage of Dutch mortgages in a multi-asset portfolio is illustrated in Figure 3. In the chart three efficient frontiers are plotted, which show the optimized risk-return profiles that can be achieved from the available assets. Most investors will be restricted in the weight that they can allocate to mortgages, but a maximum allocation of 10% already results in a substantial higher return for the same risk.

Dutch Mortgage Index

LoanClear’s Dutch Mortgage Index serves several purposes. As illustrated in this article, the index could be used for strategic asset allocation. Furthermore, it can be used to benchmark a mortgage portfolio. Next to a market weighted index, LoanClear also offers customized indices that allow mortgage investors to benchmark their mortgage portfolio with a portfolio with similar segment weights or track the performance of specific segments.

References

[1] Bloomberg – 2022-09-28

[2] AQR – A Better Alternative: Diversify Your Diversifiers

[3] AQR – The Stock/Bond Correlation

[4] BNP Paribas AM

[5] Defau, L. & De Moor, L. (2020) - The investment behaviour of pension funds in alternative assets: Interest rates and portfolio diversification

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