Asset-backed securities (ABS) are securities whose value and income payments come from, and are backed by, a specified pool of underlying assets. Similar to equities and corporate bonds, ABS can cover a wide range of underlying asset classes.
The case for European ABS
Since 2008, European ABS have consistently traded at higher spread levels than unsecured bank bonds, while offering steady floating-rate returns and full security over a pool of identifiable and tangible assets.
This produces a market anomaly of being paid more to hold on to a more secure asset. This anomaly arises for a several reasons, but most importantly it stems from the post-crisis regulatory environment in Europe, which makes ABS unattractive to own for investors, such as insurance companies, that would previously have bought them.
UK and European ABS can offer solid returns and have a very robust credit performance. Default rates have been very low both pre and post-the financial crisis – as the European Commission highlighted in September 2015, since the start of the crisis, default rates on AAA-rated European residential mortgage-backed securities (RMBS) have not risen above 0.1%.
Our ABS credit analysts have extensively modelled UK and European ABS and believe they can withstand a huge amount of macro-economic pain before the bonds suffer even a penny of losses.
Overall, ABS can present an attractive investment proposition with the flexibility to allow investors to tailor their portfolios to a specific risk or return appetite.
ABS can offer investors:
- a premium over other similarly rated fixed income asset classes
- floating rate returns which protect against interest rate rises
- security against ring-fenced assets
- a strong credit track record
The ability to tailor risk and return in ABS allows us to construct portfolios that can perform various roles in our investors’ asset allocation:
- A low risk portfolio (AA rated) yielding Libor +2.0% as an alternative to gilts or investment grade corporate bond mandates;
- Medium risk portfolios (A / BBB rated) yielding Libor +4-5% as an alternative to corporate bond strategies;
- High yield portfolios (BB rated) yielding Libor +8-10% as an alternative to high yield corporate bonds, hedge funds, private equity or emerging markets debt.