Touchstone Securitized Income ETF (TSEC)

The Touchstone Securitized Income ETF (TSEC) is an actively managed bond fund focused on securitized debt — securities created by pooling mortgages, auto loans, or other financial obligations into tradeable instruments. By concentrating on this specific corner of the fixed-income market, TSEC provides investors with exposure to credit risk across many borrowers, bundled into holdings that pay regular income.

What securitized bonds actually are

Securitization is a financial engineering process. A bank originates mortgages or auto loans, then sells those loans to a special-purpose entity, which repackages them as bonds and sells them to investors. The investor receives a stream of payments carved from the underlying borrowers’ monthly payments. A mortgage-backed security (MBS) is the most common type; others include asset-backed securities (ABS) collateralized by auto loans, credit-card receivables, or student loans.

The attraction to issuers is that securitization lets them move loans off their balance sheet and raise cash without tying up capital. The attraction to investors like TSEC is that securitized bonds offer yield higher than plain Treasury bonds while being backed by a diversified pool of underlying credit — hundreds or thousands of individual borrowers whose monthly payments flow through. If a few borrowers default, the loss is spread; the security does not fail because of any single debtor.

A broad palette of securitized paper

TSEC holds a wide variety of securitized instruments, not just mortgages. The fund’s mandate permits holdings in mortgage-backed securities from both government-sponsored enterprises (Fannie Mae, Freddie Mac, Ginnie Mae) and private issuers, plus asset-backed securities tied to auto loans and other consumer credit, and occasionally more complex instruments like collateralized debt obligations. This breadth means that credit risk is not concentrated in any single sector.

The fund’s managers favor shorter-duration, investment-grade securities, according to the fund description. Investment-grade means the credit quality is solid — rated BBB or higher by the major rating agencies — reducing the risk of outright default. Shorter duration means the bonds’ interest rates reset more frequently, insulating them from large price swings if overall interest rates move sharply.

Active management in a structured world

TSEC is actively managed, meaning the fund’s portfolio managers make selective choices about which securitized bonds to hold, rather than simply tracking an index. This allows them to hunt for relative value — spots where a particular mortgage-backed security or asset-backed bond offers attractive yield relative to its risk. It also means they can shift exposure based on their outlook for interest rates and credit conditions.

The trade-off is that active management costs more. The fund must pay portfolio managers and analysts to research securitized bonds, and that cost is embedded in the expense ratio. The fund’s managers must outperform a passive alternative (such as a broad securitized-bond index) by enough to justify the fee; historically, many active fixed-income funds fail to do so, especially in the securitized space where credit selection is harder than in unsecured corporate bonds.

Income generation and interest-rate risk

TSEC’s primary appeal is income. Securitized bonds pay regular coupon payments, which TSEC passes through to shareholders (or reinvests, depending on the investor’s selection). The yield is higher than Treasury bonds but typically lower than non-investment-grade corporate bonds, reflecting the diversified credit risk and the implicit government backing of agency mortgage-backed securities.

The risk comes from interest rates. If overall interest rates rise, the value of existing bonds falls, because new bonds are being issued at higher yields. TSEC, despite its managers’ preference for shorter-duration securities, is still exposed to this rate risk. A bond portfolio that protected itself completely against rising rates would pay such low yields that the fund would have little appeal. The fund must therefore accept some price volatility in exchange for meaningful income.

Credit risk and prepayment risk

A less obvious risk is prepayment risk, which is unique to mortgage-backed securities. When interest rates fall, homeowners rush to refinance their mortgages, prepaying existing mortgages early. The investor gets their principal back sooner than expected, at a time when reinvestment rates are low — a frustrating outcome. Conversely, when rates rise, homeowners hold mortgages longer, extending the fund’s duration beyond what the stated maturity suggests. Skilled portfolio managers try to navigate this trade-off by choosing mortgages likely to behave favorably under various rate scenarios, but the outcome is never certain.

There is also base-case credit risk: if economic conditions worsen, default rates among the underlying borrowers can rise, reducing the fund’s income and potentially impairing principal. This risk is lower in agency mortgage-backed securities (those backed implicitly by the federal government) than in private-label mortgage or asset-backed securities, but TSEC can hold both, so the exposure varies based on the portfolio composition at any moment.

How to research TSEC

Investors interested in TSEC should start with the fund’s prospectus and the most recent quarterly fact sheet, which break down the holdings by type (what percentage is mortgage-backed, what percentage is asset-backed), by credit rating, and by duration. The quarterly holdings list shows the specific securities held and their weightings, though in practice the holdings change frequently as managers trade.

Comparing TSEC’s yield to the yields on plain Treasury bonds and broader investment-grade bond indices gives a sense of whether the added credit risk is being compensated fairly. The fund’s rolling returns (one year, three year, five year) versus a securitized-bond index reveal whether active management is adding value. Because the fund is relatively new (launched mid-2023), investors should monitor its performance through several interest-rate cycles before drawing definitive conclusions about manager skill.

The expense ratio is also worth scrutinizing: active securitized-bond funds vary significantly in cost, and a high fee can bleed returns over time.