Asset backed securities (ABS)

OVERVIEW

Asset backed securities (ABS) at Royal London Asset Management

Asset backed securities, or ABS, are a type of bond that are typically issued by a bank or other lender. The difference between ABS and other conventional bonds are that ABS bonds are ‘secured’ against an underlying pool of assets or cashflows.

These assets are usually loans of a similar type such as mortgages, auto loans, student loans or credit card debt, which generate cashflows from their regular interest and principal repayments. In turn, this then pays investors’ coupons on their ABS bonds.

Why invest in ABS?

We believe complementing traditional portfolios with ABS solutions can enhance yields and diversify sources of returns, helping to build stable portfolios that have the potential to succeed over the long term.

Higher yield

ABS can offer a higher yield for the equivalent risk compared to corporate or government bonds (see chart 1 below). Investors can benefit from the ‘complexity premium’ due to the specialisms required to understand the underlying assets and how they operate within each securitisation.

Lower default rates

Historical performance through several economic cycles (see chart 2 below) have shown that ABS typically have a very low default rate. (Source S&P, weighted average of European RMBS one-year default rates, 1988-2023 (%), AAA – 0.06%, AA – 0.01% A – 0.01% BBB – 0.06%)

Interest rate protection

Almost all UK and European ABS are floating rate, which means they have near zero interest rate risk. This can make them less volatile in an uncertain interest rate environment than traditional fixed income.

Diversification

Investors can access exposure to underlying consumer or private lending assets. Through ABS, investors can diversify their portfolios away from traditional corporate risk and benefit from enhanced risk-adjusted returns.

Flexibility and investor protection

The granularity of ABS capital structures means investors can choose an investment risk and return profile to suit their appetite. And as the underlying assets of ABS transactions sit within a separate legal entity, they are protected from a lender’s failure.

Transparency

Frequent reporting of the underlying assets is provided by the issuers. This allows for investors to view the performance of the collateral pool and manage their portfolios accordingly.

Better returns for equivalent risk

Chart 1: This example shows securitised spreads versus corporate spreads

ABS Graph - Better returns for equivalent risk.jpg Source: RLAM, for illustrative purposes only.

Strong investor protections

For investors seeking to invest in the most senior tranches of the securitised market, the protections are significant. The image below examines the AAA tranche of a UK residential mortgage-backed security (RMBS). The chart shows that house prices could fall immediately by 40%, and never recover, at the same time as defaults going to many multiples of their worst ever experience before investors suffered any loss.

Chart 2: This example shows the robustness of AAA UK residential mortgage-backed securities (RMBS): Darrowby No6 PLC Tranche A

141497_WC RLAM WEB 0005_ABS strong investor protections chart Hi Res.jpg Source: RLAM, Land Registry UK, UK Government and UK Finance. For illustrative purposes only. As at December 2024. Past performance is not a guide to future performance.

Why Royal London Asset Management for ABS?

Reliable and proven

Well resourced

Real world lending experience

Reliable and proven. We have an established, specialist ABS team who have worked together for over 10 years. They have joined our proven fixed income team, which has a history of producing superior risk adjusted returns for our clients. We aim to use our resources to follow a research driven process to fully understand the complexities of the assets and maintain portfolios of high-quality securities at the right price.
Well resourced. To ensure we fully understand the risks and rewards that exist in this specialist market, we have a highly experienced staff of 7 people now working in securitised assets, with a further 2 more dedicated staff scheduled to join in the first half of 2025. They in turn can draw on the resources of our well established and experienced Fixed income, Property and Responsible investment teams. The ABS team have successfully demonstrated their expertise in analysing and managing asset backed securities, based on their understanding of the legal structures of those assets, the origination processes of the underlying lenders and the value of any collateral, such as real estate.
Real world lending experience. The team has extensive experience of not only investing in the securitised structures, but also of underwriting the sorts of assets that form the underlying loans in these pools. Our team has seen the full spectrum of behaviours on display during the market cycles in consumer, financial and corporate credit. This means that they understand the nature of the end borrowers in these vehicles, and not just the asset’s price, but its true worth.

Our team

We continue to build a high quality and experienced team across all areas of private and public debt markets, as part of our commitment to sourcing the most efficient sources of returns for our clients.