Asset-Backed Investing Moves Mainstream

The packages of loans, once a niche in professionally managed portfolios, are increasingly being added to public and private funds for yield and diversification benefits.

Pools of auto loans can be packaged into securities known as ABS. (Dreamstime)

Investments based on consumer loans are having a moment. Pools of auto loans, credit-card receivables, and small-business loans (to name just a few of the many categories) can be packaged into securities known as ABS and traded by professional investors, or sold directly to investors who are eligible to take part in the growing and increasingly popular market for private credit.

The investments are attractive to both sets of investors for essentially the same reasons this year.

First, the pools often get top credit ratings, are short term (with little interest-rate risk), and yield more right now than high-rated corporate debt, which is historically expensive as measured by the very low yield spread over Treasuries. At the end of August, Morningstar’s ABS index yielded 4.55% with a triple-A rating, while Morningstar’s index of one- to five-year corporate loans yielded 4.24% with a lesser single-A rating. The short-term Treasury index yielded 3.66%.

In a Sept. 30 report, Goldman Sachs analyst Ben Shumway explained that the higher yields on ABS are due to lingering worries about the health of the U.S. consumer, but he finds them an attractive income source nonetheless. He expects consumers to hold up fine and notes that there are extra investor protections in ABS in case they don’t.

“The asset-backed securities market not only offers an attractive spread pickup relative to corporate bonds, but has also evolved to be structurally safer than its pre–global financial crisis form,” he writes.

Like corporate credit, ABS are trading at yields that offer a smaller spread over Treasuries than usual, so they shouldn’t be considered cheap, per se, says John Kerschner, head of U.S. securitized products at Janus Henderson Investors. “But spreads are nowhere near as low as they are on investment-grade corporate credit,” he says.

In July, Janus Henderson launched an exchange-traded fund, Janus Henderson Asset-Backed Securities , with a yield of 4.67% according to Morningstar. The company also offers Janus Henderson Securitized Income ETF, which has some lower-rated issues as well as securitized business loans and mortgage loans. Launched in November 2023, it yields 5.86% and has grown to $1.2 billion in assets.

“It’s a very big market that most people don’t have a lot of exposure to,” says Kerschner. “I think they should.”

Generally, ABS are bought by institutional investors and added to funds owned by individual investors. ABS makes up just 0.44% of the iShares Core U.S. Aggregate Bond ETF, which tracks the main bond benchmark.

But many income funds with a broader mandate are adding more securitized credit to their portfolios. Pimco Multisector Bond Active ETF is one example. The $8 billion-in-assets fund is about 40% in securitized assets, compared with 26% for its category, according to Morningstar. It yields 5.1% and is up 8% this year, putting it in the top 20% of all U.S. multisector bond funds. Portfolio manager Sonali Pier says that asset-backed loans offer diversification and yield.

Janus Henderson Multi-Sector Income is about 65% in securitized assets, up from 50% normally, says Kerschner. That fund yields 6.4% and is also in the top 20% of multisector bond funds, according to Morningstar.

“Portfolio managers figured out that asset-backed loans can be a nice complement to either traditional long-only public bond funds and also private debt funds,” says Shannon Saccocia, chief investment officer for wealth at Neuberger Berman. Especially on the private side, there’s a lot of variety in terms of asset classes represented, yield, and credit risk, making it a useful diversification tool in portfolios, she says.

Pimco’s Pier agrees that asset-backed loans stand out compared with corporate direct lending right now. “It’s in earlier innings and better relative value,” she says.

More ABS funds. Janus isn’t alone in offering new asset-backed funds. DoubleLine Asset-Backed Securities ETF launched in March and yields 4.78%, according to Morningstar.

Another example is Neuberger Berman’s NB Asset-Based Credit Fund, which launched in August. Like many of the new entrants, it mixes private and public asset-backed securities, and, because of the lack of liquidity in private markets, is structured as a so-called interval fund, which typically only allows quarterly redemptions that can be gated if a lot of investors try to redeem all at once.

“The market is not fully saturated, which is why we’re seeing more strategies launched,” Saccocia says. “There is a huge universe of opportunity that is probably underrepresented in traditional private wealth portfolios.”

John Hancock CQS Asset Backed Securities, another interval fund, launched in January. Janus Henderson bought Victory Park, a private asset-based lending company, last year. It doesn’t have a public-private vehicle currently.

Consumer strength. While ABS generally garner top ratings from credit-rating firms, they are subject to risk if the economy falters and consumers and small businesses have trouble paying back their loans.

In the past, the most attractive time to venture into the sector has been when the consumer is stressed, such as during the regional-bank crisis in the spring of 2023, says Saccocia. There may be better opportunities ahead, she notes.

But, for now, relative to corporate credit, many investors find the high credit ratings, yields, and ample liquidity (at least among ABS) worth considering, says Seth Henry, a portfolio manager at Sage Advisory. “Investors aren’t having to compromise liquidity in order to facilitate this trade,” he says. “I would expect demand in the ABS space to remain strong until other opportunities present themselves.”

Write to Amey Stone at amey.stone@barrons.com