Asset-Backed Securities and CLOs: Focus on High Quality, New Issue
We prefer short, senior CLO tranches and new-issue commercial and aircraft ABS.
Ongoing concerns about the longevity of the current credit cycle, memories of the fourth quarter 2018 selloff, and reduced investor interest in floating-rate securities all weighed on CLO spreads during the third quarter. Our thesis over the last 12 months to favor short, senior CLOs has worked as expected: Pricing for short, senior CLOs remained steady, but pricing for riskier subordinated tranches weakened by 10–45 basis points in the third quarter. Total returns over the last 12 months AAA CLO tranches returned 3.52 percent, while total returns for subordinated BBB and BB securities returned just 2.83 percent and 2.72 percent, respectively.
Senior CLO Tranches Outperformed Subordinate Tranches in the Past Year
Senior CLO tranches have outperformed subordinate tranches on a nominal basis (and especially on a risk-adjusted basis) over the last 12 months.
Source: Guggenheim Investments, JP Morgan. Data as of 10.31.2019.
Investors have not been adequately compensated to assume the additional credit and spread duration risk of subordinated CLO securities. While weakening spreads did not materially impact new issuance volumes in the third quarter of $25 billion, refinance and reset volumes were anemic. We remain cautious on subordinated CLO investments, and believe short, senior CLO tranches have a superior investment profile for the remainder of the year.
The sharp interest rate rally has caused nominal yields in ABS securities to decline since the beginning of the year. However, credit spreads for certain ABS subsectors widened over the same time.
Nominal Yields Have Fallen Since the Beginning of the Year
Issuance in $millions, YTD 2019
Credit spreads for certain ABS subsectors have widened. The underperformance of ABS credit spreads is owing to those securities’ weak call protection, not credit concerns. As interest rates declined, prices rose and investors increasingly focused on yield to call analytics.
Source: Guggenheim Investments. Data as of 11.5.2019.
The underperformance of ABS credit spreads is owing to those securities’ weak call protection, not credit concerns. As interest rates declined, prices rose and investors increasingly focused on yield to call analytics. With relatively long open periods, or timeframes in which borrowers can refinance existing ABS without any prepayment penalty, esoteric ABS are prone to call and reinvestment risk in sharp interest rate rallies. These risks were particularly acute in 2019's rate rally. Seasoned esoteric ABS have drifted toward premium dollar prices over the year, and when combined with short non-call periods and long open periods, the spread and yield profiles vary widely on a yield-to-call and a yield-to-maturity basis. To address these concerns, we have focused our investment activity on new issuance and shied away from premium-priced secondary offers. Par-priced new issuance avoids the skewed return profiles and offers extended call protection compared to more seasoned premium priced securities. Our investment focus remains on bespoke opportunities and new issue commercial ABS and aircraft ABS.
—Peter Van Gelderen, Managing Director
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.
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*Assets under management is as of 09.30.2019 and includes leverage of $11.8bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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