3 questions on fixed income for 3Q 2019
Our answers for three bond questions investors may ask.
When investing in fixed income, the traditional options would include US Treasuries and investment-grade bonds. But fixed income goes beyond bonds and spans non-traditional assets such as securitised credit.
Now, you may have come across the acronyms, “ABS” and “MBS”, and wonder if they may be describing alphabet soup. They are non-traditional debt securities created from the pooling of:
Securitised credit is little understood and yet it is a key part of the fixed income universe. Many are floating rate securities, and will vary according to the prevailing interest rate movement.
The MBS universe in the US can be categorised into agency and non-agency MBS. As agency MBS are issued by quasi-government agencies, they are perceived to be backed by the US government. Non-agency MBS are issued by private entities such as financial institutions.
High-rating agency MBS, for example, currently look attractive after the widening in spreads. These securitised products are now yielding 3.65%, compared with 2.91% in late December 20171. In addition, their 2018 supply has been running lower than 2017, which helps buffer the greater supply in the market from the US Federal Reserve’s run-off of MBS on its balance sheet.
Our base case for 2019 remains one of positive economic growth in the US, albeit at a slower pace compared with 2018. Admittedly, recession risks are on the rise, but the very tight labour market, rising incomes and still-low interest rates continue to provide a solid foundation for US consumer ABS credit trends.
The relatively strong lending condition may reduce concerns about the near-term credit performance of most ABS sectors. In particular, US consumer balance sheets are still looking healthy with households’ aggregate debt burden, as well as credit card and auto loan charge-offs, all remaining at low levels.
The US securitised credit market has evolved and undergone much development over the past 10 years. Today, leverage in the US financial system is lower and loan underwriting standards are enhanced. As a savvy investor, it is worthwhile to bear in mind the risks before investing in the securitised credit market. Nonetheless, investment risks could be mitigated through diversification with the help of an active manager.
So consider beyond the traditional, and mull over the potential benefits nourishing alphabet soup can bring to a fixed income portfolio.