Adam Castle, partner and portfolio manager at Lord Abbett, answers SCI's questions

Q: When did Lord Abbett begin investing in securitised products? Was there a specific driver behind its decision to enter the market?
A: Lord Abbett has been a multi-sector fixed income investor since the 1970s and we started investing in securitised products in the early 1990s, so the firm has a long history of evaluating opportunities in a wide range of market sectors. Securitisation provides exposure to the household balance sheet - auto loans, student loans, credit cards and so on - and real estate, where there is a lot of value to be found. Securitised bonds provide greater returns for the equivalent rating than corporate bonds, so it pays to invest the time and resources to invest in the asset class. 

However, an actively managed approach is necessary to achieve yield. The difference between corporate bonds and securitised bonds is loss given default: going down in quality in a securitisation means surrendering a range of security rights. Ensuring that you’re being properly compensated for the risk therefore requires active surveillance and monitoring of performance, together with a strong trading team to allow you to exit a position and find liquidity should you need it.

Q: How does Lord Abbett differentiate itself from its peers?
A: One differentiator is our scale and resources: deep resources are needed to benefit from the opportunities in the securitisation market. We have a large team of 17 specialists in securitisation and invest across asset classes and the capital stack. We also leverage technology and proprietary tools, which provides us with a persistent edge when screening for opportunities.  

Q: Where are you seeing value in the securitisation market at present and why?
A: A key nuance at Lord Abbett is our view that vintage matters a great deal. For example, last year was a good vintage for consumer ABS because of the tight underwriting that emanated from the fear around households navigating inflationary pressures. The market expected a painful transition, but it didn’t materialise.

We expect 2024 to be a good vintage for commercial real estate because peak fear equals an opportune time to create risk in conservative structures and at low entry points in assets being discarded by sellers. The bid/ask is wide for CRE – people need to sell and others need to buy, in an illiquid environment, so the market has been whittled down to those that must transact – resulting in high quality loan origination at decent prices and with certain structural protections.

Q: Why are CLOs such an attractive proposition right now?
A: At Lord Abbett, we’re not fans of exogenous forces that we’re not in control of. CLOs have strong predictable cycles, which means we’re better able to deal with supply events and we don’t have to take undue risk in terms of entry and exit.

The predictability of CLOs stems from the fact that all participants in a transaction are economically-driven; in other words, CLOs hold assets and seek to finance assets, and all parties derive returns from the vehicle. It is a closed system: when one part of the system is squeezed, it pulls back until equilibrium is restored.

We’re involved at all levels of the capital stack, so we can see the entire relative value picture, which helps us pick our spots in the CLO market. Our CLO specialists also work closely with our leveraged loan teams to understand pricing and fundamentals in the underlying bank loans.

Student loan ABS is at the opposite end of the predictability spectrum because it is difficult to forecast cashflow on the bonds, as a change in administration can have a dramatic effect on prepayment profiles. Performance is largely driven by policy decisions; therefore, while there may be extra value to be had in the sector, the tail risk is also wider.

Q: Which attributes do you look for in a CLO manager?
A: We typically take into account a CLO manager’s alignment of interest, track record and resources. Triple-A rated CLO tranches are very liquid and while there is a degree of commoditisation at this level of the capital stack, we find that there are tiers of liquidity within the sector, as not all bonds are equal.

We bucket CLO liquidity into tiers, having identified numerous factors to predict how a CLO triple-A tranche will price. Top tier bonds are excellent - among the most liquid - but it is vital to have an actively managed approach to create value in this segment. Of course, CLOs themselves are actively managed vehicles, so they can change over time and migrate in tier.

There are a number of potential flags that we keep an eye on to try to minimise such a risk. At the triple-A level, these tend to be more manager-related, such as the loss of a portfolio manager or a challenging organisational change. At the BBB/BB level, loan management matters more.

Q: What is your outlook for the securitisation market this year?
A: Our outlook as a firm is that there are many reasons to suggest we’re currently in the late stage of the economic cycle. Expansion is slowing down and tight financial conditions persist, which can be causes for concern.

However, the resilience of the economy is very apparent and conducive to being overweight high-grade risk, while outyielding benchmarks and peers with assets we have high confidence in. Right now, we follow more of a middle-of-the-fairway approach than a barbell approach.

While 2022 was the year of panic, due to widespread fears of recession, 2023 was the year of relief and saw spreads compress and inflation subside. In 2024, it is becoming apparent that the panic may have been premature. There is a clear resiliency in the economy, so we see justification for maintaining exposures to numerous high-quality credit sectors.

Corinne Smith