DoubleLine Commercial Real Estate ETF (DCRE) Marks One-Year Anniversary on NYSE ARCA

How DCRE ETF works

ETF strategically invests in three main types of fixed income securities, all linked to commercial real estate (CRE): Agency and non-Agency Commercial Mortgage-Backed Securities (CMBS) and Commercial Real Estate Collateralized Loan Obligations (CRE CLOs).

Agency CMBS are backed by government agencies and are considered lower risk, while non-Agency CMBS are not government-guaranteed and carry a higher risk and potential return. CRE CLOs are structured finance vehicles and a type of non-Agency CMBS that is comprised of a pool of loans backed by  various commercial properties, offering investors diversified exposure to commercial real estate debt, which includes debt backed by apartment, office, retail, hotel and industrial properties. 

DCRE aims to achieve two primary objectives: current income and capital preservation. For current income, the ETF boasts a 5.13% 30-day SEC yield. However, a more critical figure for investors to consider is the yield to maturity (YTM) of 6.26%. The YTM is a more comprehensive measure that considers the total returns expected if all of DCRE's holdings are kept until they mature.

For those wary of the bond bear market of 2022, DCRE's portfolio is also designed to mitigate the impact of similar market downturns. With an average duration of just 1.09 years across its 140 holdings, the ETF is positioned to be less sensitive to interest rate changes.

Why active management?

The standout feature DCRE compared to its counterparts, like CMBS is its active management approach. Unlike a passive strategy that might merely sample an index, DCRE's team actively selects the bonds, allowing them to express nuanced views, such as choosing to avoid certain property types that may be underperforming, like office properties.

Active management in

also allows for a broader investment universe, including Agency and non-Agency CMBS, CRE CLOs, and even floating rate CMBS, which are often excluded by indexes. About one-third of DCRE’s portfolio is comprised of these floating-rate securities, expanding the fund's diversification and potential for returns.

The value of active management extends to bottom-up credit analysis of individual issuers. The DoubleLine team delves into the collateral and loan capital structure of each investment, a process that uncovers opportunities missed by a broad index approach.

For example, this detailed examination can include evaluating cash flows from specific loans, such as those secured by hotels, and assessing risks and opportunities on a state-by-state and loan-by-loan basis.

"Our approach isn't rules-based - every asset and borrower have a story. We rely on our process and our experienced team to navigate these complexities," Chen added, highlighting DCRE's ability to adapt to changing market conditions in a way that passive ETFs, bound by index rules, cannot.

How DCRE manages risk

With current headlines spotlighting CRE exposure in regional banks and lingering concerns from the 2008 subprime crisis, it's natural for investors to have some apprehension regarding the types of securities held by DCRE.

Chen emphasized the active monitoring of their holdings as a key strategy to mitigate sector-specific risk.

"One way we mitigate sector-specific risk is by having a process in place to actively monitor our holdings. This ensures that the underlying properties of the bonds are performing as expected. If a property's performance has declined, presenting a material downside, our processes enable us to be proactive in divesting," he says.

This flexibility allows DCRE to adjust its investments based on the fundamentals of each property, unlike passive CRE ETFs, which select securities based on the rigid criteria of an index.

Focusing on the portfolio's structure, Chen pointed out that DCRE leans towards AAA-rated exposures and maintains a very low loan-to-value (LTV) ratio exposure.

"Structurally, it would require a significant downturn for a AAA bond to be impacted, due to its high seniority and priority in the capital structure," Chen says. "For those concerned about the accuracy of ratings, we suggest looking at the leverage—specifically, the LTV ratio, which stands at anywhere between 30% to 40% on average. This inherently means that the value of the underlying building would need to decline by 60% to 70% before a first dollar impairment occurs at a AAA level," he says.

AAA ratings indicate the highest credit quality, implying minimal risk of default. The LTV ratio, which measures the loan amount against the property's value, offers an insight into the risk level; DCRE's low LTV exposure suggests substantial safety margins.

Finally, Chen explains that even in light of the 2008 crisis’s rating accuracy issues, DCRE seeks to mitigate risk via diversification and the underwriting of each credit in the portfolio.

"Considering a CMBS with a multi-borrower pool, this would imply that entirety of the pool would need to default and value be impaired by at least 60% to 70%—a scenario that, given the diversification of the underlying pool in terms of property types, geographic locations, and borrowers, has historically not occurred," Chen says. “We don’t just take the rating at face value; we meticulously analyze the underwriting, capital structure, and subordination levels," he says.

Overall, DCRE's approach underscores the value an active management team brings to navigating the complexities of less liquid, more nuanced fixed-income investments.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.