The past few months have seen asset managers encouraging investors to look at securitised credit (MBS / ABS). Their pitch in a nutshell: diversification from conventional fixed income, healthy returns over the past 15 years (GFC aside), value in an “unloved” sector while traditional bonds are rich, and a complexity premium given that the instruments are famously difficult to value. Investors are told that pre-‘GFC’ problems in MBS have been addressed: reliance on credit ratings has decreased with more loan-level analysis and third-party due diligence; misaglined compensation practices in mortgage origination have been tackled by risk-retention rules; loans are underwritten to a more conservative standard.
Yet there are notable headwinds in play. The Federal Reserve is beginning to unwind its Agency MBS purchases. Valuations are tight. The level of issuance in non-Agency RMBS remains low thanks to tighter lending standards and banks’ preference for agency loans in their portfolios, although shortage of supply can be positive for pricing. Interest rate volatility can be detrimental to for MBS performance, although the key relationship – that between prepayment risk and rates – is exceptionally hard to model.
The sector has seen substantial changes since 2013. While Non-Agency RMBS issuance has dried up due to reduced origination of these mortgages, managers have turned their attention to newer sub-sectors such as GSE Credit Risk Transfers (CRT), Re-REMICS, RPLs/NPLs and SFRs. Not everyone is on board: certain managers claim to stay away from CRTs, arguing that high demand has made them expensive and that they have not been tested through a housing downturn.
Within the universe of managers, the large differences between US and European securitised credit strategies persist, with the US market enabling a large number of standalone Agency MBS offerings while European managers invest across a range of ABS and MBS. One notable development since 2013 is the rising number of unconstrained fixed income strategies covering government and corporate debt as well as securitised credit, providing investors with another way to get their feet wet in this asset class.
The time seems right for a fresh examination of the sector. What do investors need to know about securitised credit now? What are the key questions for manager selection? How should investors cope with the lack of appropriate benchmarks and the difficulty of assessing performance? This paper offers a brief introduction. Further questions would be welcome.
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