Tranches 

Tranches 

Tranches provide investors with a flexible and customisable way to invest in the stock market. By dividing securities into multiple parts, investors can choose to invest in a portion of a larger investment that is aligned with their risk profile and desired returns. While tranches can be more complex than traditional investments, they offer a unique way to diversify a portfolio and earn higher returns. 

What are tranches? 

To be marketable to various investors, tranches are divisions made from a pool of securities—typically financial instruments like bonds or mortgages — divided according to their time to maturity, risk, or other factors. To appeal to a wide spectrum of investors, each part or tranche of a securitised or structural product is one of the multiple linked securities issued simultaneously but with different risks, rewards, and maturities. 

 

Understanding tranches 

Tranches have become increasingly popular in the investing world due to the flexibility they offer to investors. Tranches are commonly used in structured finance products such as mortgage-backed securities, collateralised debt obligations, and asset-backed securities. 

Tranches also help in creating a more liquid market for securities. Junior market investors willing to take on more risk can invest in the lower tranches, while more conservative investors can invest in the senior tranches. This allows issuers to access a wider range of investors and improves the market’s liquidity. Tranches also help to  reduce an  investment’s overall risk by spreading it across different tranches, thus reducing the impact of any default in a single tranche.  

A tranche is a valuable tool in the investment world that allows for better risk management and improved market liquidity. It is particularly useful in complex and high-risk investments like mortgage-backed securities, where it helps balance risk and reward for different investors. 

Basics of tranches 

The growing use of securitisation to split up occasionally hazardous financial assets with consistent cash flows and then sell such divisions to other investors has sparked the recent creation of tranches in structured finance. The French term meaning slice is where the word tranche is derived. 

In transaction paperwork, the distinct tranches of a bigger asset pool are often described and given multiple classes of notes, each of which has a particular bond credit rating. 

Bonds, loans, insurance plans, mortgages, and other obligations are a few examples of financial items that can be separated into tranches. 

Investment strategy in choosing tranches 

Longer-maturity tranches appeal more to investors looking for reliable long-term cash flows. On the other hand, investors who want more immediate yet profitable income streams favour tranches with faster maturities. 

When investing in tranches, it is important to have a solid strategy in place. As an investor, it is important to understand the different tranches available and the associated risks and rewards.  

One common strategy is to focus on higher-rated tranches, which typically offer lower risk but also lower yields. Another approach is to invest in a diversified portfolio of tranches, which can help to spread risk and maximise returns.  

Tranches make investing in debt more complicated and can occasionally be an issue for ignorant investors who are at risk of selecting a tranche that is inappropriate for their investment objectives. 

It is also important to carefully analyse the underlying assets and the structure of the tranche, as well as the overall market conditions and economic outlook. Investors can achieve attractive returns while minimizing their risk exposure by taking a disciplined and strategic approach to investing in tranches. 

Example of tranches 

A common real-world example of tranches is the mortgage-backed securities (MBS) market. In this market, banks bundle different types of mortgages into packages, then sell to investors in tranches.  

Each tranche represents a different level of risk and reward for the investor. This allows investors to choose the level of risk they are comfortable with and invest accordingly. A senior tranche is the least risky, while a junior tranche is the riskiest. Senior tranches receive priority in receiving payments from the underlying mortgages, while junior tranches are paid last.   

In the case of MBS, tranches allow banks to manage their risk and still earn a profit while providing investors with various investment options. 

tranches 

Frequently Asked Questions

There are three main types of tranches: senior tranches, junior tranches, and mezzanine. Senior tranches are considered less risky and have a higher priority in receiving payments from the underlying assets. On the other hand, junior tranches are considered riskier and have a lower priority in receiving payments. Junior tranches have higher potential returns than senior tranches, but they also come with a higher risk of default. 

Investors can use tranches to organize their investment income and earnings to meet their cash flow requirements. Investors with a shorter time horizon may purchase investments with shorter maturities, whilst those with a long-time horizon may purchase investments with longer maturities. 

The determination of tranches can vary depending on the type of investment, but generally, tranches are determined based on the creditworthiness of the underlying assets or securities.  

For example, in mortgage-backed securities, tranches are determined based on the creditworthiness of the homeowners whose mortgages are pooled together to create the security. The higher the creditworthiness of the homeowners, the lower the risk associated with the tranche.  

Investors can then choose to invest in a tranche based on risk tolerance and investment goals. In summary, tranches are determined based on the underlying creditworthiness of the assets or securities and are used to offer investors different levels of risk and reward. 

Tranching is a technique used in the investment world that involves dividing a large pool of assets into smaller, more manageable portions. One of the main advantages of tranches is that it allows investors to choose the level of risk they are comfortable with.  

For instance, in a mortgage-backed security, tranches allow the investors to choose between the senior tranche, which is less risky but has a lower rate of return, and the junior tranche, which is riskier but has a higher rate of return.  

 

Junior tranches are considered to be the riskiest. Any assets may not back junior tranches or be unsecured, increasing their risk. To assist investors in making up for the increased credit risk, the junior debt tranches may pay a greater interest rate than senior tranches. 

Related Terms

    Read the Latest Market Journal

    From $50 to $100: Unveiling the Impact of Inflation

    Published on Apr 12, 2024 35 

    In recent years, inflation has become a hot topic, evoking strong emotions as the cost...

    Japan’s Economic Resurgence: Unveiling the Tailwinds Behind Nikkei 225’s Record Leap

    Published on Apr 11, 2024 52 

    Source: eSignal, Intercontinental Exchange, Inc. In the heart of Japan’s economic landscape, the Nikkei 225...

    Weekly Updates 8/4/24 – 12/4/24

    Published on Apr 8, 2024 92 

      This weekly update is designed to help you stay informed and relate economic and...

    What Makes Forex Trading Attractive?

    Published on Apr 2, 2024 172 

    In a world where the click of a button can send goods across oceans and...

    Weekly Updates 1/4/24 – 5/4/24

    Published on Apr 1, 2024 93 

    This weekly update is designed to help you stay informed and relate economic and company...

    How to soar higher with Positive Carry!

    Published on Mar 28, 2024 124 

    As US Fed interest rates are predicted to rise 6 times this year, it’s best...

    Why 2024 Offers A Small Window of Opportunity and How to Position Yourself to Capture It

    Published on Mar 28, 2024 171 

    With the Federal Reserve (FED) finally indicating rate cuts in 2024, we witnessed a significant...

    Weekly Updates 25/3/24 – 29/3/24

    Published on Mar 25, 2024 75 

    This weekly update is designed to help you stay informed and relate economic and company...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com