Asset-backed securities (ABS) do not deserve to be the “great maligned” asset class that they are, and investors should look at the investment “not the fashion”, said Richard Quin, managing director and head portfolio manager at Bentham Asset Management.
The year “2008 was a liquidity event for this asset; that can happen in any asset. The credit quality of these assets was good, and they performed well through the liquidity crisis,” Quin said, speaking in a panel at the 2017 Investment Magazine Fixed Income, Cash and Currency Forum in July. “ABS are a good asset for people to invest in, but they don’t want to hear about it.”
Participating in the same panel, George Lin, senior investment manager at Colonial First State, said the fund started investing in ABS via total return, unconstrained mandates in 2007.
“During the financial crisis, the spread of ABS securities was widening slowly until Lehman, and then went through the roof,” Lin said. “But we persisted with our managers and they got all their performance back. There was not a single default in CMBS [collateralised mortgage-backed securities] or ABS in our manager’s portfolio.
“Our approach is to give managers unconstrained-type mandates so they can take on different opportunities.”
ABS are financial securities that are backed, or secured, by a pool of underlying loans. They are dependent on the quality of the underlying loan.
There has been much change in the ABS sector since the crisis, Lin said, including the standard investor base moving from mostly hedge funds to more institutional investors.
“This gives me a little bit more comfort,” he said. “But I do have to admit, we haven’t got through a stressful market scenario since 2008-09.”
He said one of the most important lessons from the crisis was to be aware of liquidity.
“If we had been forced to sell, our experience would be totally different,” he explained. “We weren’t forced because we have strong inflows, and a lot of other liquid assets in fixed income and other asset classes.”
He also said it was important to be aware that, in a crisis, correlations are very different to what they are in normal markets.
“Our approach would stay reasonably constant in a crisis market. How much confidence you have in your managers, and how much confidence your manager has in you are important. The worst thing to happen is your manager tells you to sell.”
Lin said Colonial First State has much discussion with managers about the outcome it wants to achieve and how much drawdown it can tolerate. The collaborative process with managers also involves them coming back to change guidelines as markets evolve.
“It’s a collaborative process, and the way we work with managers more and more. We don’t take the standard mandate, all mandates have become a lot more customised.”
Bentham’s Quin agreed that much has changed in the ABS asset class since the crisis, including decreases in gearing.
In addition, ratings agency behaviour has changed and they have improved their process of communication, along with changing their rating criteria and adopting tougher standards, he said.
He also said that while agency risk is difficult to remove, it has improved, and more attention is paid at origination, with managers having skin in the game.
He also agreed with Lin that more attention is being paid to due diligence.
“They have improved in subordination, origination standards have become more stringent, and pricing is somewhat attractive,” Quin said.