What’s in store for bonds in 1Q 2021 as economies reopen?
1Q 2021 bond themes and potential opportunities as economies reopen.
You may have come across the acronyms, “ABS” and “MBS”, and wonder if they may be describing alphabet soup.
They are non-traditional, interest-bearing debt securities created from the pooling of:
So why do some fund managers choose to invest in securitised debt1, 2, and what are the roles ABS and MBS could play in an investment portfolio?
1. Diversified income sources and risks
An exposure to a broad mixture of US securitised assets1,2 could provide important diversification to the portfolio.
In periods of market stress, securitised debt such as ABS and MBS could help diversify income sources and risks. Agency MBS, for example, have exhibited uncorrelated returns to risk assets such as developed market equities and US credit or corporate bonds, and could act as a hedge to portfolios.
Still, securitised assets of all kinds were marked down earlier this year as a result of forced liquidations of leveraged investors in the space, and thus did not provide the diversification we would have expected. The various liquidity support programmes put in place by the US Federal Reserve (Fed) and other central banks have gradually calmed the market, and securitised assets such as MBS have been delivering positive performance in recent months3,4.
Diversifier in times of market stress4
Unlike equities and corporate bonds, which are more closely tied to corporate balance sheets, securitised debt’s underlying assets are mostly loans extended to individuals - this means tapping into the balance sheets of consumers. And they are largely supported by trends in US consumption strength and declining household debt5. Consumer demand remains relatively well-supported by fiscal stimulus.
2. Resilience in market downturns
Securitised debt also demonstrated resilience in market downturns3. During periods when the S&P 500 Index delivered negative returns of more than 5%, ABS, non-agency commercial MBS and non-agency residential MBS have demonstrated more resilience compared to equities and high-yield (HY) corporate bonds6.
An allocation to non-agency mortgages could help manage portfolio volatility.
Returns7* during periods of S&P 500 drawdown (> -5.0%)
3. Relatively consistent returns3
Historically, securitised debt have broadly generated relatively consistent returns. Agency securitised debt, for example, are issued or guaranteed by US government-related bodies. They demonstrate defensive characteristics and could be considered as an alternative to US Treasuries.
US MBS also demonstrated lower volatility3 versus US Treasuries. The Fed’s asset purchases helped technical factors turn positive for agnecy MBS1,2. New mortgage relief policies from the US government also helped keep borrowers in their homes and avoid buyouts.
Volatility of US MBS and Treasuries8
Major central banks are likely to continue with asset purchases and keep rates low for years. There will be occasional bouts of market volatility, but there are still potential investment opportunities across the full fixed income spectrum. With relatively low correlation to risk assets, adding securitised debt to a portfolio could help diversify income sources and risks1,2.