Investors seek ABS protection against turning macro cycle
As the late stages of the economic cycle drag on and uncertainty around the next recession grows, investors are turning to securitization as a shield against headwinds from other parts of the market, loading up on ABS to insulate portfolios from gyrations in corporate credit
Since the financial crisis, investors have been drawn to securitization by the embedded protections in the structures, many of which were a response to the subprime mortgage debacle. At the same time, underwriting standards have tightened, risk retention and incentive structures have improved and rating agencies have become more conservative, making securitized products more likely to outperform other sectors when markets come under stress.
“During and right after the crisis, no one wanted to trust securitized products, but the table has turned,” says John Kerschner, head of US securitized products at Janus Henderson in Boulder, Colorado. “People are getting the message that what caused the last crisis isn’t going to cause the new one.”
Barings, the investment arm of insurer MassMutual Life Insurance, is one example of asset managers going overweight on securitized products. It has increased allocations to ABS, CMBS and RMBS to 30% in its Global Investment Grade Strategy Fund, and has allocated another 30% to CLOs. The remaining 40% funds emerging market debt, corporate bonds and other assets.
This allocation is a big increase from late 2018, when the fund was launched. At that time, about 20% was allotted to securitization, says Yulia Alekseeva, head of securitized credit research and portfolio manager at Barings in New York.
“We made that determination because we are seeing good value in the securitization space,” she says. “We look at securitized products as a more defensive place to stay as we feel some more recessionary-type sentiment.”
Compared with corporate or high yield bond markets, securitization outperformed in 2019 and is expected to continue to do so in the coming year, according to Barings’ global IG strategy fund team. “What we are hearing from the consulting community broadly is that the special purpose vehicle, bankruptcy remote feature is valuable today, as well as the seniority structure,” says Doug Trevallion, the firm’s head of global securitized and liquid products. “I hadn’t heard that in a long time. Securitization is becoming quite attractive and accepted as we move into the late cycle climate.”
ABS is also seeing more cross-over issuers, both from different regions and those crossing over from other sectors.
“There’s more street participation and also more international investors — not just European, but also Asian investors,” says Trevallion.
Issuers that used to participate in the corporate space are tapping ABS via asset classes such as whole business loan securitizations or cell tower deals. ABS has proved to be a cost-efficient form of capital, with the added benefit of ratings that are often higher than an issuer’s unsecured corporate rating.
“We have seen some movement into the securitized products space,” says Geoff Caan, managing director of public fixed income, at SLC Management in Boston. “Investment banks continue to expand in the ABS area and work with originators to source more products and co-ordinate securitization of new assets.”
Several asset managers have been particularly active in increasing RMBS exposures, attracted by continuing house price appreciation across the US and a benign interest rate environment for refinancings and new mortgage production.
Overweight in RMBS
“Going heavy on securitized products is the right way to approach this market,” says Dave Goodson, head of securitized products and portfolio manager at Voya in Atlanta. “In our dedicated securitized products fund, we definitely pointed risk towards real estate — RMBS are benefiting from higher prepayments.”
For Income Research + Management, the big change has been to increase agency RMBS as well, the “third leg of [their] value stool,” says Jake Remley, senior portfolio manager at the firm in Boston. Janus Henderson has also added more agency RMBS to its multi-sector income strategy fund, because it looks relatively cheap versus corporate debt, says Kerschner.
However, pockets of risk still exist in the subordinated tranches of most securitized asset classes. Especially in esoteric ABS, now is not the time to buy anything and everything, says Philip Armstrong, senior portfolio manager at Invesco’s structured investments team in Atlanta, Georgia. For Invesco, that means sticking to higher quality names with a track record of issuance.
“The theme is to get defensive and to buy securitized [product] in lieu of corporates,” says Remley. “But if you are not differentiating what your manager is buying, you could end up with securitized products that are riskier fundamentally and technically than even a triple-B or double B corporate bond.”GC