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| Brendan Galloway |
Galloway is head of the enhanced cash team, which is part of the European cash management desk at BGI in London. He is responsible for $3-4 billion in asset-backed securities. The investments are denominated in euros, sterling and dollars.
What place do asset-backed securities have in a cash
management strategy?
Asset-backed securities are an ideal investment for clients of the cash management desk who have a cash balance of a predictable size over a predictable period of months or years and don't need the liquidity afforded by the money markets for this portion of their cash position. These clients typically want the credit risk and duration profile of cash, but are looking for some pick-up in yield. They're investing in ABS for enhanced longer-term returns, rather than being arbitrage-driven like many players in the ABS market.
At BGI we manage $35 billion across different cash strategies, of which $3-4 billion is invested in ABS. Clients can decide whether to invest in funds that consist purely of money market instruments, ones that have a 15-20% allocation to ABS or ones that are 95% invested in ABS, depending on their liquidity needs.
What is your approach to investing?
Our goal is to build a diversified ABS portfolio of quality deals. We invest across geographies, consumer and commercial, and in asset classes including RMBS, CMBS, CLOs and other types of ABS.
Do you stick to triple-As given your clients' low risk tolerance?
For the most part we do, but we don't believe that all triple-A assets are created equal. There are multiple issues to consider outside of the triple-A rating--for instance, that ratings are based on legal final maturity, whereas actual returns are affected by the expected final maturity. The two can differ significantly. You can't invest blindly in triple-As and expect to end up with a homogenous risk profile. So there's no getting away from doing a thorough analysis of each deal and the risks inherent in it, whatever the ratings. In our funds, we can buy ABS floaters from triple-A to single-A with an expected maturity out to 10 years.
The fact that esoteric deals can get done very quickly and at tight spreads in this market indicates to me that there could be a lot of investors out there who mistakenly look only at triple-A ratings and spread hurdles without thinking through relative value. Sometimes the European ABS market can look complacent, as evidenced by the lack of tiering between issuers and maturities.
Where do you still see value?
Interestingly, shorter-dated granular prime residential mortgage-backed securities are looking more attractive again. Not in terms of all-in spreads, but on a relative basis. With regard to maturity, the term structure of RMBS is so flat, that there is hardly any pick-up between, say, three- and six-year notes. Investors aren't getting paid to go out along the curve and the value is now at the shorter end. In terms of granularity, we think the relative value of commercial mortgage-backed securities is fading. We've seen a number of pretty chunky deals with quite a lot of headline risk, where the pricing is still very tight.
One area in particular where we still see value is in U.K. non-conforming RMBS. These deals are de-leveraging as pre-payment rates speed up driven by rising interest rates, and hence the credit enhancement goes up. There's more credit protection in the structure of the deal and in addition we are very confident in the ability of select issuers and servicers in the sector to manage down delinquencies should that be necessary.
How does BGI approach investing in some of the
more esoteric assets?
As portfolio managers we are operating under time and liquidity constraints. It's great to be told that there's good relative return in a deal, but if we have to spend a lot of time analyzing the deal, we might be better off looking at a number of lower-yielding deals rather than the one higher-yielding deal. Also, liquidity in the secondary market is very important to us. In theory, it's nice to buy a rare triple-A deal at LIBOR plus 45 basis points; however, if there's only one counterparty in the market who knows the deal and I need to sell it, chances are I'm going to take a big hit.