What Is a Structured Investment Vehicle?
A structured investment vehicle (SIV) is a pool of investment assets that attempts to profit from credit spreads between short-term debt and long-term structured finance products such as asset-backed securities (ABS).
Structured investment vehicles are also known as conduits.
Understanding Structured Investment Vehicle (SIV)
A structured investment vehicle (SIV) is a type of special purpose fund that borrows for the short-term by issuing commercial paper in order to invest in long-term assets with credit ratings of between AAA and BBB. Long term assets frequently include structured finance products such as Mortgage-Backed Securities (MBS), Asset-Backed Securities (ABS), and the less risky tranches of Collateralized Debt Obligations (CDOs). Funding for SIVs comes from the issuance of commercial paper that is continuously renewed or rolled over; the proceeds are then invested in longer maturity assets that have less liquidity but pay higher yields. The SIV earns profits on the spread between incoming cash flows (principal and interest payments on ABS) and the high-rated commercial paper that it issues. For example, an SIV that borrows money from the money market at 1.8% and invests in a structured finance product with a 2.9% return will earn a profit of 2.9% - 1.8% = 1.1%. The difference in interest rates represents the profit that the SIV pays to its investors, part of which is shared with the investment manager.
In effect, the commercial paper issued matured sometime within 2 to 270 days, at which point, the issuers simply issue more debt to repay maturing debt. Thus, one can see how structured investment vehicles often employ great amounts of leverage to generate returns. These financial vehicles are typically established as offshore companies specifically to avoid regulations that banks and other financial institutions are subject to. In essence, SIVs allow their managing financial institutions to employ leverage in a way that the parent company would be unable to do due to capital requirement regulations set by the government. However, the high leverage employed is used to magnify returns which when coupled with short-term borrowings exposes the fund to liquidity in the money market.
Structured investment vehicles are less regulated than other investment pools and are typically held off the balance sheet by large financial institutions such as commercial banks and investment houses. This means that its activities do not have an impact on the assets and liabilities of the bank that creates it. SIVs gained much attention during the housing and subprime fallout of 2007; tens of billions in the value of off-balance sheet SIVs was written down or placed into receivership as investors fled from subprime mortgage related assets. Many investors were caught off guard by the losses since little was publicly known about the specifics of SIVs, including such basics as what assets are held and what regulations determine their actions. Toward the end of 2008, no SIVS remained in operation.