Bart Bakx, head of ABS and mortgages at NN Investment Partners, explains why securitisation and private credit currently represent sweet spots in the fixed income market

Q: Do you believe private credit will take on a more significant role in investor portfolios in 2021? If so, which factors are driving this forward?
A: We see that many investors are undertaking searches and these are increasing towards private credit. Looking for opportunities to allocate, investors seek alternatives in the private market space in view of continued volatility of the public markets and to mitigate the potential impact of rising inflation and interest rates. There are a number of compelling features that have been driving this trend forward; for example, diversification from established public credit products, pick-up in spreads and the ability to cater to specific needs for investors.

Furthermore, a changing and increasingly challenging regulatory environment puts pressure on banks’ balance sheets and creates opportunities for other institutional investors to step in and fill the gap. In addition, you may hold these loans at amortised cost instead of market value, which reduces valuation volatility, which is a great feature for insurance companies and pension funds and you get rewarded for accepting illiquidity or complexity in your investments.

Q: Why are the infrastructure, real estate and trade finance sectors likely to be of particular interest to investors currently?
A: For commercial real estate loans and trade finance, the floating rate nature - which is a benefit in times of inflation - spread pick-up and low volatility are factors that are compelling and hence the demand and interest in these sectors.

Q: How does the yield pick-up compare between these sectors and other asset classes?
A: In the ABS markets, the spread pick-up ranges from 10bp-100bp for triple-A rated ABS and for investment grade ABS, the pick-up versus investment grade credit bonds is approximately 85bp. Trade finance rated triple-B can offer around 350bp more, which is quite a bit better. For CRE loans, it is a bit lower and typically you see spreads on average of 200bp, depending on the loan and underlying asset quality.

Q: Why do current ABS spread levels provide an attractive entry point?
A: Securitisation did not recover from the Covid-19 widening as fast as investment grade credit, covered bonds or government bonds, as the purchases by the ECB in this market has been disappointing. The newly introduced Pandemic Emergency Purchase Programme did not spend a single euro for the purchase of securitisation.

So, while there has always been a basis between securitisation and investment grade credit in favour of securitisation, this basis has grown substantially. On average, single-A rated securitisations now trade wider than triple-B rated investment grade corporates. We already see added demand for this floating rate asset class, so we expect this basis to correct and believe now is the best time to start investing in securitisations.

Q: Can you provide more detail around the utility of securitisation in an uncertain inflationary and interest rate environment?
A: Most publicly traded bonds in the investment grade space are fixed rate products, while securitisations are floating products. With interest rates at an all-time low and expected to rise on the back of inflationary pressure, securitisations are at the sweet spot. Securitisations are the only liquid fixed income asset class with a floating rate character and can be added to a broader fixed income portfolio as a diversifier as a protection from inflation.

Q: What is your outlook more broadly for the European securitisation market?
A: The demand in this asset class is growing as investors are looking for yield, diversification away from the traditional fixed income products and protection from inflation. The ABS new issue market is performing very well.

Currently, all new issues are oversubscribed massively. We expect this to continue for the medium term and expect spreads to tighten.

Q: Do you foresee any challenges in the year to come in this space?
A: The negative effects of the pandemic have been muted, due to the monetary and government supports. But once the safety blanket is taken off, it is yet to be seen what will happen.

The biggest risk with investing in securitisations is a rise in unemployment rate, as the investors are mostly exposed to consumer risks. However, ABS structures are extremely robust.

In the aftermath of the global financial crisis, rating agencies were overly cautious, which led to more transparent and robust structures with more credit support. But even if you look at the spike in unemployment rate during the GFC, together with sharp decline in house prices, European ABS performance was solid.

We think that the GFC was a worse situation than what we currently face. Therefore, we do think that there will be challenges ahead, but we are not overly concerned.

Angela Sharda