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29 Nov 23 Insight Fixed Income Challenger Investment Management

Global Opportunities in Asset Backed Securities

The global asset backed securities market provides investors with high quality, yield enhancing and diversifying investment opportunities. Traditionally thought of as mortgage-backed product, the asset class increasingly offers a wider range of investment opportunities across a broad selection of consumer and corporate credit profiles.

Why do we see value in global asset backed markets?

The asset class has existed and evolved since the 1970s. It continues to offer investors a structural opportunity for enhanced yield compared to similarly rated corporate credit, with long term default rates for similar ratings which are broadly similar.

More than a decade on from the Global Financial Crisis, we continue to find that deal structures have improved markedly, resulting in significantly lower credit risk. Underlying loan pool underwriting standards have generally improved and structural enhancements mean investments are designed to withstand increasingly severe stress scenarios as ratings across the capital structure increase.

With the increased oversight of the asset class there has been a shift towards better transparency, standardisation and availability of loan and performance data.

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Floating rate opportunities form a large portion of the asset class. Typical investment profiles have expected repayments within 1 to 5 years which is faster than traditional corporate credit exposures, reducing the underlying volatility and correlation of asset backed finance with traditional growth assets. These features provide the asset class with a natural diversification benefit to traditional fixed income products due to the insulation from interest rate and credit spread duration risk.

The combination of floating rate, short duration and a robust performance outlook meant that the during the UK LDI crisis in Sept 2023, asset managers were able to carry out large sales of highly rated securitised bonds at relatively low discounts to par. This experience stood in stark contrast with more traditional long duration fixed income instruments which experienced large capital losses and consequently extreme illiquidity during this period. We estimate that over a 3 week period roughly $15 billion in securitised bonds traded, a telling demonstration of liquidity and demand for the asset class.

A wide range of jurisdictions, asset classes, underlying collateral types and capital structures means that relative value opportunities continually present themselves within this space as performance outlook and investor appetites across sectors change. The complexity of the asset class does necessitate specialised investment management with deep experience and expertise a pre-requisite. Underwriting a corporate borrower is a very different skillset to underwriting a highly granular and diversified pool of collateral as well as how the cashflows from that collateral will pass along a bespoke cashflow waterfall structure.

This wide range of securitisation markets also gives rise to attractive niche markets, such as the Australian non-bank mortgage market. Despite being relatively niche, the opportunities in these markets can be large and provide attractive relative value for investors who have the able to engage with them.

A final point relates to the regulatory environment. Following the Global Financial Crisis, global regulatory bodies established a framework of rules intended to prevent excessive risk taking within the banking, insurance and pension fund ecosystems. Forcing risk outside of the regulatory system increased the cost of asset backed capital, allowing alternative financiers to step in to fill the gap that emerged. Even today, more than a decade after the Global Financial Crisis, these regulatory gaps persist.

Challenger IM Global ABS Fund

The Challenger IM Global ABS Fund is available to institutional investors to extend CIM’s existing range of products which aim to exploit inefficiencies in the pricing of credit risk across public and private markets. To date, all funds have invested across corporate, securitised and real estate backed credit targeting returns of between 3% and 8% per annum over cash. The CIM Global ABS Fund is CIM’s first offering which provides dedicated access to securitised credit. With over A$8 billion invested in securitisation markets, investment experience dating back to 2005 and 14 investment professionals dedicated to ABS investing, the team has developed a strong edge in this relatively niche part of the credit landscape.

The Fund will target a 3-4% per annum through the cycle return before fees over the Euro Short Term Rate by investing predominantly in publicly rated investment grade opportunities across global developed securitised markets, with a particular focus on Europe, UK, Australia and opportunistically in the US. By selectively blending attractive private market opportunities with public market transactions, the Fund will offer incremental yield in addition to diversification away from more traditional strategies. It will focus on floating rate assets with exposure to interest rate and currency hedged.