Industry Voice: Diversified ABS — a truer exposure to asset backed securities?

One of the problems with credit markets is classification conventions. If you look at sterling credit index methodologies, you will see a lack of consistency between providers on bond and sector categorisations. Asset Backed Securities (ABS) reflect this perfectly.  

At RLAM we extensively use secured bonds to enhance return or reduce risk in client portfolios. However, not all these bonds will be termed asset backed securities. The industry - asset managers, banks, and index providers - have deemed ABS to cover only a sub-set of secured bonds. Our Diversified Asset Backed Securities Fund helps to illustrate the key points of difference between our approach and the narrower designation.  

ABS conventions  

There are two broad ways to get exposure to bonds with enhanced collateral: securitisations and secured corporate bonds. It is the former that most ABS funds focus on. In securitisations, debt is raised against a specific pool of assets held within a special purpose vehicle (SPV). Examples include auto loans, residential mortgages, student loans, and credit card loans, and these are generally concentrated towards consumer-related sectors. Tranches are issued which reflect priority of claim on cashflows and underlying assets; there is no recourse to the sponsor if things go wrong. Most securitisations are issued as floating rate notes, referenced to a variable market interest rate, e.g., Sterling Overnight Interbank Average (SONIA).  

Secured corporate bonds are fundamentally different, although clearly falling within a definition of being asset backed. Secured bonds are issued by companies, who pledge assets as collateral. Typically, these bonds are fixed coupon, with maturities of five years and more. Covenants are generally in place so that if the value of the collateral falls below a threshold (x1.5 or x1.6 the value of bonds outstanding) the issuer is obligated to pledge more collateral. 

In our Diversified Asset Backed Securities Fund we offer clients exposure to both securitisation and secured corporate debt, with a focus on being a senior lender. We have a rich heritage in both areas, having been investors in the first sterling residential mortgage-backed securities (from Lloyds and Santander) and the first sterling covered bonds (issued by Leeds Building Society, secured on prime mortgages) after the Global Financial Crisis. Post crisis, banks had to offload assets via securitisations - we were well placed to look at these structures given our significant experience in secured corporate bond investing.  

Continue Reading 

This was a paid post by Royal London Asset Management

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author's own and do not constitute investment advice.