After years of abundant liquidity and low interest rates, investors are becoming more and more attuned to a pending regime change. Monetary policy is being recalibrated to contain inflation, raising volatility in bond markets. With inflation set to be higher for longer fixed coupon bonds are vulnerable.
Where does that leave structured products? We believe they can offer many advantages that make them complementary to other credit strategies:
- A proven track record across market cycles
- Characteristics such as floating rates that are suited to the current context
- Diversification and exposure to the real economy.
Robust process and enhanced regulation
The procedures for monitoring securitisation markets have evolved significantly since the 2007/2008 crisis:
- Rating agencies are now obliged to apply tougher standards before assigning a AAA rating to a product
- Originators must retain 5% of the securitised assets on their balance sheets to ensure their interests are aligned with those of the investors
- On the investor side, dedicated asset-backed-security (ABS) teams need to monitor and assess the underlying assets in detail.
In sum, it is no longer possible for issuers to unload credit risk under a triple ‘A’ label to insufficiently informed investors. Stricter regulation and greater awareness are enabling investors to make the most of the benefits of securitisation strategies compared to other credit strategies.
Advantages in the face of cyclical changes
By design, securitisation products offer exposure to the real economy. The underlying assets are often loans to households (for real estate, cars, etc.) and corporate loans. The diversity of these assets makes it possible to benefit from a high degree of risk diversification in a (euro) market currently worth around EUR 1 200 billion.
We currently favour the three most active segments in terms of issuance. This helps ensure that our exposure can be renewed regularly:
- Residential mortgage-backed securities involving personal mortgages
- Consumer ABS, and in particular car loans or car leasing; this sub-segment has the highest granularity of issuers with loans with relatively short maturities (2 to 3 years)
- Collateralised loan obligations, or securitised corporate loans.
Our focus is 100% on floating rate securities (with +1 month or +3 month Euribor coupons). We believe this feature is crucial at a time when interest rates are rising: not being exposed to interest rate risk should be a clear advantage over corporate bonds. Our triple ‘A’ ABS strategy targets only the most senior tranches, i.e. those that are the most secure in the structure and first in line for cash flows.
These strategies offer an attractive risk premium (see Exhibit 2). This risk premium reflects the ‘stigma’ of the 2007/08 crisis (mentioned above), the necessary means to monitor and analyse ABS (the so-called complexity premium), and the difference in regulatory treatment in terms of capital cost between corporate bonds, ABS and CLOs.
ESG and other features
Our portfolios fall under article 8 of the Sustainable Finance Disclosure Regulation (SFDR) and are fully integrated into BNP Paribas Asset Management’s Environmental, Societal and Governance (ESG) policy. The in-house Sustainability Centre (SC) assesses and rates issuers. The average ESG scores of the securities in the portfolio must exceed the average of the ABS market benchmark (Barclays Bloomberg Pan European Floating-rate note (FRN) ABS index).
Apart from a triple ‘A’ rating for 100% of the assets, Fitch rates our strategy itself triple ‘A’. Its duration of around 0.8 years (end-January 2022) is explained by the fact that all of the assets held are floating rate securities. The allocation between the various market segments is managed actively. Given the market characteristics, our long experience in this asset class, and our rigorous and transparent approach, we see our ABS strategies as offering a safe haven to investors looking for shelter from rising interest rates as central banks move decisively to contain inflation in 2022.