M&G Credit Income Investment Trust

What are asset-backed securities (ABS)?

ABS are bonds backed by an underlying pool of assets, such as mortgages, auto loans or credit card loans. Investors receive regular, variable interest payments generated from these borrowings. ABS bonds mature over short-to-medium time horizons.

Interest payments are prioritised through a process called ‘securitisation’, where bonds are placed into ‘tranches’ (slices) according to their prospective risks. Investors can choose to be first in line to receive interest payments by investing in senior tranches, which offer lower potential returns. Investors in junior tranches are placed at the back of the queue to receive payments and therefore demand higher compensation, but also face greater risks of not receiving the expected full amount, as they must absorb potential losses before other investors.

The trust may invest in mezzanine tranches, which sit between the most senior and junior tranches. This can provide higher potential income than the senior bonds alongside higher protection than junior tranches.

What’s the opportunity?

European ABS could offer a substantial income premium over conventional government or corporate bonds that carry the same level of credit risk. One reason is the lack of standardisation among transactions, which are often backed by a large number of underlying loans and require extensive resources to analyse. M&G has developed sophisticated proprietary research tools to help gain a demonstrable edge in evaluating deals and modelling potential future scenarios. We are often approached before deals have come to market.

Historical defaults on senior European ABS are very low over multi-decade periods, including during the 2007-09 global financial crisis and COVID-19 pandemic. This is partly due to the typically robust underwriting and credit processes in place across Europe, particularly compared to the US.

We are also finding an increased number of potential opportunities in Asia Pacific – for example, we recently invested in ABS backed by personal loans originated from a new technology platform in New Zealand with a strong reputation for responsible lending. These loans are typically used for home improvements or debt consolidation. 

What is real estate debt?

Real estate debt (or ‘commercial mortgage loans’) consists of loans made to commercial property owners to finance the purchase or redevelopment of real estate. This real estate may comprise offices, hotels or retail properties, which the borrower rents out to tenants.

Loans are secured against the physical real estate, which provides lenders with a claim to ownership of the property if the borrower faces challenges in meeting its obligations. The property can be ringfenced and therefore legally separated from the borrower’s other assets and liabilities.

The terms of the loan will also stipulate certain ongoing conditions, such as a minimum current property value relative to the size of the loan (‘loan to value’, or ‘LTV’), and expected rental income relative to the loan’s interest payments (‘interest coverage ratios’). The borrower’s own creditworthiness is also assessed.

Repayments are subject to variable (‘floating’) interest rates and the loan term is usually three to five years.

What’s the opportunity?

M&G is one of the world’s largest investors in real estate, with around £31 billion of property assets under management¹. Real estate debt therefore represents an opportunity to combine the knowledge and resources derived from our leading positions in both fixed income and real estate markets.

When we invest in real estate debt, we normally negotiate with each individual borrower to create bespoke payment terms they are comfortable with while providing additional security for our investors.

In conducting due diligence, we will, for example, evaluate the lease terms agreed with each of the property’s tenants and assess factors such as tenancy exit and entry dates; rent reviews; potential void periods; and ongoing demand for floor space in comparable properties.

^{[1] Source: M&G, as at 31 December 2021}

What are leveraged loans?

Leveraged loans are normally used to finance mergers and acquisitions of privately owned businesses (companies not listed on public stock exchanges). Loan terms are negotiated individually between the borrower and lender. Usually, the process is led by a bank, which may fund the loan with capital provided by a group of investors.

Leveraged loans are normally rated below investment grade and therefore require extensive prior due diligence and ongoing analysis, which at M&G is performed by specialist in-house credit researchers. We take a highly selective approach to these transactions and invest in only a small proportion of the deals we evaluate.

The trust invests both directly in leveraged loans and via a holding in the M&G European Loan Fund, which is only available to professional investors and institutions.   

What’s the opportunity?

Investors are being increasingly drawn to leveraged loans due to their potentially higher levels of income than high yield bonds; their relatively short maturities; variable interest rates, which could protect against interest rate rises; and, in many cases, additional levels of safety provided by senior secured loans. 

What is Senior and Junior debt?

When a company borrows money, its outstanding debts are ordered in terms of priority for repayment should the firm ever struggle to meet its financial obligations. Creditors that hold senior debt are first in line to receive any money owed, but they typically receive lower interest rate payments than other lenders. Holders of junior debt face higher risks of not recovering all of the money they are owed, but in return they can demand higher interest rates on the money they lend.

The trust invests in a combination of senior and junior debt depending on prevailing risks and potential returns available in the market, while seeking to maintain an overall investment grade credit rating for the portfolio.

What’s the opportunity?

The trust’s ability to invest in alternative forms of credit means that it can access senior debt that may offer a significant premium over conventional investment grade corporate bonds. Many of these potential opportunities currently exist in the asset-backed securities, commercial mortgage loans and leveraged loans markets.

At times, markets can also present potential opportunities to invest in investment grade senior bonds at higher interest rates. In such instances, the trust may invest a greater proportion of the portfolio in these bonds due to their potentially more attractive income for comparatively lower risk.

The trust also holds a small amount of junior debt, which is designed to boost overall portfolio returns. When the outlook for default rates is low, the potential benefits of owning these assets – particularly those with short-to-medium maturities – can outweigh the risks.