European ABS Outlook
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Topics
Long-Term Outlook, Opinion, Alternative Fixed Income
Published
December 18, 2024
Read time
11 mins
Author
Egbert Bronsema
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In an environment where there's a lot of things changing: sentiment, fundamental performance, it is good to have that additional carry in your investments. And that's something that ABS inherently has due to its floating rate and exposure to the front and not the long end of the curve.

ABS in 2024: Steady returns amidst a sea of volatility

When it comes to market volatility, 2024 has been quite the year. With geopolitical issues, the continued effects of inflation and high cost of living, and the hike in interest rates, few asset classes and investor expectations have been left unaffected.

 

In the ABS (Asset Backed Securities) sector, even when faced with an increased cost of living, the consumer has remained in good health. And in the face of market turmoil, its floating-rate structure left ABS significantly less impacted. Even more so, thanks to its pickup compared to traditional fixed income, ABS has been able to provide stable returns in a volatile environment.

 

How do you view the current macroeconomic environment and consumer fundamentals?

Since the Covid crisis, consumer savings levels across Europe have risen, surpassing expectations set by inflation and cost of living pressures. Which, for an asset class backed by consumer risk, is a welcome sign. And from a consumer perspective, the prospect of decreasing interest rates and inflation, it only gets better for them.

 

On the other hand, expectations of increasing unemployment could impact performance on a fundamental level. But as it currently stands, the job market remains tight and there has been no rise in bankruptcies.

 

How are ABS expected to perform in a decreasing interest rate environment?

"In an environment where there's a lot of things changing: sentiment, fundamental performance, it is good to have that additional carry in your investments. And that's something that ABS inherently has due to its floating rate and exposure to the front and not the long end of the curve."

 

From a fundamental perspective, lower interest rates are more favorable for performance. On the other hand, this can decrease the coupon on a floating interest rate product like ABS. However, over the last two years, we have observed a lot of volatility on the back of growth and inflation expectations, including varying outlooks for interest rates across markets. An ABS investor is affected to a lesser extent by expectations of interest rate moves (that tend to move the longer end of the interest curve), as their carry is primarily affected by the front end of the curve. As rate curves are inverted, this results in a higher current yield that is, on average, 80-90 basis points higher than the yield to maturity.

 

What is your outlook for the asset class and where in the investment universe do you see relative value?  

Apart from what has already been mentioned on the fundamental side of things, from a demand/supply technical, we have seen spreads tighten as a significant increase in supply has been met with an increase in demand. As investors recognize the benefits of this asset class: stable income, consumer exposure, and having that higher carry in an uncertain environment, we have seen a lot of inflow into ABS funds.  

 

There has been increased issuance from banks, who, with fading ECB stimulus and no purchasing programs, need to mitigate risk from their balance sheet. As a result, we have seen more issuance from Italy, Spain, France, and the Netherlands as banks need funding to generate more consumer lending. We expect this to continue because, as interest rates go down, credit availability is better, and conditions are favorable for consumer lending and consumer lending institutions, and issuance will increase.

 

On the other hand, demand remains bullish with spreads above comparable interest rate products. And with the added benefit of a floating interest rate, we anticipate carry to be the main performance attributor for ABS in 2025 again.

 

Owing to our loan-level data analysis and trustee reporting and monitoring systems, any deterioration in asset fundamentals can be averted by choosing not to invest or divest, whether that’s on a sector or single issuance level. But overall, we believe that the outlook for ABS is looking good from a fundamental perspective.

 

 

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Author

Egbert Bronsema
Portfolio Manager

Egbert Bronsema is a portfolio manager in the European ABS team. Prior to joining the firm, he worked for eleven years as a portfolio manager and an analyst in the structured finance team at IMC Asset Management. 

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