In the decade following the 2008 global financial crisis (GFC), securitised assets in the US have undergone significant reforms. Changes to market practices and regulation have resulted in greater transparency and reduced risk. As a result, interest in securitised products is beginning to grow among Asian institutional investors keen to juice up their portfolios. But, as Doug Weih points out, there still needs to be a better understanding of the benefits and risks inherent within the sectors where the assets derive.
As co-head of fixed income at Aegon Asset Management US, Weih is an 18-year veteran of the company’s securitised products with oversight of its structured finance portfolio management team. Weih believes these fixed income instruments offer long-term investors seeking access to the US debt market’s (e.g. consumer, real estate and middle-market corporate lending) valuable opportunities.
Also known as structured finance, structured credit or structured products, exposure to securitisation can be an important tool in optimising fixed income portfolio performance.
Securitised products include:
- Asset-Backed Securities (ABS) – secured by non-mortgage collateral
- Residential Mortgage-Backed Securities (RMBS) - backed by residential mortgages
- Commercial Mortgage-Backed Securities (CMBS) – collateralised by mortgages on income producing commercial and multifamily properties
- Collateralised Loan Obligations (CLO) – backed by actively-managed middle and large-sized business loans
According to Weih, institutional investors in Asia are eyeing securitised products with increased interest as they seek diversification and yield. “Asian investors have been big buyers in US treasuries and corporate debt and with increasing hedging costs, they’re looking at US fixed income to provide attractive risk adjusted returns.”
“We’ve definitely seen a pick-up in the last 12 months, in requests for more information from Asian investors particularly in the ABS market. Some of those wanting to know more about these asset classes are relatively new in the market and are coming up the curve so they want us to to help them better understand the asset class. Other investors like commercial real estate because it’s a hard asset and they understand it, so they want to focus on CMBS.”
LARGE AND VARIABLE MARKET
Securitised products account for around 25% of the $40 trillion US debt market according to the US Securities Industry and Financial Markets Association (SIFMA). In comparison to other sectors such as investment grade credit, securitised investments offer attractive value, differentiated returns and the potential to improve portfolio performance through lower correlation.
Securitised investments can be used to increase a fixed income portfolio’s diversification since underlying collateral typically comes from multiple sources, given cashflows from multiple sources are less susceptible to negative changes in any single source. It can also be used in multi-sector strategies to enhance yield, shorten duration and to maintain or improve credit quality.
ABS products are split between traditional (e.g. credit card, auto and equipment loans or leases) and non-traditional “esoteric” sectors (e.g. timeshare loans, container leases and unsecured consumer loans).
RMBS are split into either non-Agency RMBS or Agency RMBS and can be structured to pass principal and interest through to all bond holders, or tranched, to provide cashflows to meet specific investor risk/return profiles.
CLOs consist primarily of senior secured debt instruments issued by below investment grade companies (leveraged loans). CLO collateral pools normally contain loans from 100 to 200 issuers.
Aegon Asset Management US believes there are attractive investment opportunities today in parts of the CMBS and ABS markets, which Weih believes are under-represented in investor portfolios, simply because many institutional investors only have limited exposure to ABS, and CMBS securitised products.
Figure 1: Outstanding Securitised ($bn), 2017 Figure 2: Historical annual issuance ($bn)
To illustrate his point, Weih says many institutional investors invest in the Bloomberg Barclays US Aggregate Index, a $20 trillion index which contains roughly 69% treasury, government and corporate bonds and 31% securitized investments.
He says, “If you take that 31% out and break it up, you’re getting 92% agency RMBS and only 8% ABS and CMBS. With agency RMBS you’re exposed to a lot of interest rate risk. So, if you think you’re getting securitised exposure in the Barclays Aggregate, you’re actually getting very little exposure to where we’re finding value right now.”
Figure 3: Index-focused investors are overwhelmingly concentrated in Agency RMBS which does not reflect the diversity within the entire securitised opportunity set
RISK AND RETURNS
Aegon Asset Management US has been investing in securitised products since the 1980s and Weih and his team have been together since 2008, so he’s well placed to understand the post-GFC regulatory changes that affect the asset class.
Greater transparency of the underlying collateral, the alignment of incentives via risk retention of 5% of the transaction by issuers to ensure they, as Weih puts it, have “skin in the game”; and a generally more conservative and realistic approach by rating agencies are all helping encourage, and give some degree of comfort, to those thinking about investing in this sector. However, he still believes investors should never just delegate decision making on the back of a credit rating. They must do the hard yards with their own analysis, due diligence and views.
“One of our key themes across our portfolios is an overweight allocation to private-label structured products post crisis. We often say the best time to invest in the market is after a crisis because that’s when the most regulation is aimed at that market, to make sure the next crisis doesn’t happen there.”
For more information please visit Aegon Asset Management or contact Mabel Cho, regional head, Aegon Asset Management Asia, email [email protected] or Yuji Amamoto, country manager and representative in Japan, email [email protected]
This article does not constitute an offer or solicitation for the sale of any product or service. The views expressed herein are not intended as investment advice and should not be construed as a forecast or guarantee of future results. The asset classes described herein may not be suitable for your specific needs and you should contact a locally licensed professional for advice. Aegon Asset Management US is not regulated in most jurisdictions and may not be authorized to market or conduct business in a given country.