Private assets
Spotlight on ABS – a source for diversification and attractive returns?
6 min read 14 May 25
Follow us
Peilin Bao
Matthew Wardle
When it comes to Structured Credit, the characteristics and strengths of ABS (“asset-backed securities”) tick the boxes for an array of investors. Peilin Bao, Investment Grade ABS Fund Manager and Matthew Wardle, Fund Manager and Head of Investment Grade ABS, offer their insights.
Investors are gradually getting to grips with ABS. How exactly do they work?
ABS1 are bonds backed by a pool of loans with similar characteristics encompassing a range of domains, whether for residential and commercial property, student financing, automobile purchases or consumer needs. First developed some 30 years ago in Europe, ABS are engineered using a process known as securitisation which serves to convert illiquid loans into tradeable liquid securities. A securitisation mutual fund purchases loans from a bank before issuing tranched, floating-rate ABS. Its purpose: to provide investors with a range of risk/return profiles within the same structure. Depending on the payment priority or ‘payment cascade,’ investors receive monthly repayments of capital and interest from borrowers. Regular repayments help with forecasting cash flow. Credit risk for ABS is based on the quality of asset classes. Generally speaking, the risk of defaulting is reduced, owing to the substantial number of borrowers.
For an extended period of time, these securities have triggered distrust for their role in the subprime mortgage crisis. How do ABS differ in Europe from the United States?
The regulations required of European banks to grant loans are considerably more stringent than those of their American counterparts. Subsequently, the risk of borrowers defaulting is lower on the Old Continent. More often than not, US property owners struggling to pay their mortgage can hand over the keys to lenders, with no action taken against the debtor, even when the property value is less than the outstanding mortgage. Conversely, lenders in Europe have full recourse to the borrower’s other assets. Property loss aside, the implications can be far-reaching. These past three decades, the annual weighted average default rate for European RMBS (mortgage-backed/RMBS) was 0.28% versus 4.74% in the United States. During the major financial crisis of 2007-2009, the rate for Europe was around 2%, compared to 11% worldwide. What’s more, a robust securitisation market is regarded as vital for bolstering Europe-wide capital markets – an idea that is championed on the Old Continent. Securitised products, which also include Auto ABS (backed by automobile loans), Consumer ABS (backed by consumer loans and credit cards), CLO2 (backed by corporate loans), RMBS3 and CMBS4 (backed by residential and commercial mortgage loans respectively), serve to diversify sources of funding for banks and non-bank lenders alike.
What of the latest developments in Europe’s ABS market?
This vast investment universe is reported to be worth €541bn5. Issuing volume totalled €143bn in 2024, a sharp increase on prior years. In our opinion, this signals the start of a medium-term trend for the primary market. Since European banks can no longer rely on quantitative easing practiced by central banks to ensure financing at a lower cost, they are increasingly shifting their focus to investment vehicles such as ABS. Market liquidity will improve due to ample supply. The investment universe is also set to become more diverse, both from an issuer and geographic standpoint. As such, growth in Europe’s market is expected to attract more investors. Furthermore, such growth will enable M&G and other expert investment houses to build ever-more diversified and selective portfolios.
In asset allocation terms, what are the benefits of ABS ‘made in Europe’?
These instruments represent an effective source of diversification, for a number of reasons. They guarantee exposure to an extensive range of defensive underlying assets. Thanks to monthly loan repayments, over time, ABS have the potential to upgrade their credit rating. These securities are less volatile, demonstrating low correlation with other asset classes as they are mainly exposed to granular consumer risk. And given the floating-rate loans, the yield is mostly maintained, irrespective of changes to key rates. Despite such characteristics, ABS yields are significantly higher than corporate and government bonds with an equivalent rating. From our perspective, this performance reflects regulatory and technical factors, as opposed to ABS’ credit risk. All other factors being equal, the combined growth in supply and demand looks set to stabilise the asset class’ relative valuation. ABS’ scope for diversification in asset allocations and their defensive profile make for a compelling investment case. Moreover, they are designed for the current backdrop of strong uncertainty.
How does M&G specialise in ABS?
For 25-plus years, M&G has actively invested in securitisation, earmarking €19bn6 or so in Group-wide assets under management (AUM) with €8.3bn in segregated funds. We have one of the largest Structured Credit teams across Europe, comprising 40 investment professionals with a proven track record in all aspects of securitisation and who proactively manage investment portfolios. M&G has created its very own ESG rating scorecard for ABS. The latter assesses three aspects of securitisation, namely Transactions, Assets and Counterparties (TAC). What’s more, M&G can measure its asset pool’s carbon emissions.
More recently, M&G broadened access to ABS through its M&G Investment Grade ABS Fund. Can you tell us more?
This particular fund intends to capitalise on Europe’s fast-growing securitisation market, with a focus on high-quality, defensive instruments. The investment process is supported by M&G’s pre-existing Investment Grade ABS strategies, amounting to €2.5bn7 in AUM. The fund is classified under Article 8 of the Sustainable Finance Disclosure Regulation (SFDR)* with an AA** average rating, offering daily liquidity. This serves to meet the criteria of a wider client base – catering to advisory and discretionary portfolios with low ABS exposure to date – as well as institutional investors who view ABS as an alternative to specific fixed income investments.
1 Asset-Backed Securities
2 Collateralised Loan Obligations
3 Residential Mortgage-Backed Securities
4 Commercial Mortgage-Backed Securities
5 As of 31/12/2024
6 As of 31/12/2024
7 As of 28/02/2025
*The purpose of the fund is not sustainable investment and despite promoting Environmental/Social (E/S) characteristics, the fund will not make any sustainable investments.
**Internal limits are subject to change.
The views expressed here should not be taken as a recommendation, advice or forecast..
Main risks associated with the M&G Investment Grade ABS Fund:
- The value and income from the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested.
- The value of the fund may fall if the issuer of a fixed income security held is unable to pay income payments or repay its debt (known as a default).
- The fund may use derivatives to profit from an expected rise or fall in the value of an asset. Should the asset's value vary in an unexpected way, the fund will incur a loss. The fund’s use of derivatives may be extensive and exceed the value of its assets (leverage). This has the effect of magnifying the size of losses and gains, resulting in greater fluctuations in the value of the fund.
- Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.
- The fund could lose money if a counterparty with which it does business becomes unwilling or unable to repay money owed to the fund.
- ESG information from third-party data providers may be incomplete, inaccurate or unavailable. There is a risk that the investment manager may incorrectly assess a security or issuer, resulting in the incorrect inclusion or exclusion of a security in the portfolio of the fund.
- The assets backing mortgage and asset-backed securities may be repaid earlier than required, resulting in a lower return.
- Please note, investing in this fund means acquiring units or shares in a fund, and not in a given underlying asset such as a building or shares of a company, as these are only the underlying assets owned by the fund.
Further details of the risks that apply to the fund can be found in the Fund’s Prospectus.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.