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Positioning portfolios for 2025: ABS is a solution in volatile and benign markets
Given the uncertain backdrop and limited potential for spread tightening across broader risk markets going forwards, we explore two possible scenarios for 2025 – volatile and benign – and discuss how asset-backed securities (ABS) can provide the solution in both outcomes.
In our full piece, we look at:
A volatility scenario:
- ABS has compelling properties including short spread duration, high quality, attractive carry, a floating rate nature, and embedded default protection.
- There are several potential sources of volatility this year. Furthermore, spreads are currently very tight across broader risk markets and, as such, volatility events are not priced in, which could amplify any disruption.
- Investors would benefit from volatility if they have positioned their portfolios to be floating rate, higher quality, shorter spread duration with higher carry, as these characteristics can provide some cushion to drawdowns.
- Securitised credit markets are, by nature, skewed towards higher ratings. In addition, bonds typically have shorter spread duration versus investment grade corporates and are floating rate. Finally, due to technical factors such as high supply, spreads and carry are attractive.
A more benign environment:
- The properties of ABS are still beneficial and at the same time catalysts, such as ratings upgrades, can lead to more spread compression and a higher total return.
- Tight spreads today limit the potential for spread tightening going forwards, but with the potential for a stable economic backdrop, and if inflation is well-behaved, there is a good chance that we see spreads remain range-bound in 2025.
- A catalyst is needed to generate a higher total return. An example is targeting bonds that are likely to receive rating upgrades. Then, post upgrade, you can sell at a tighter spread, not only generating the carry received whilst holding the investment, but also the price appreciation having sold the bond at a tighter spread.
- ABS has an exceptional record of rating upgrades. ABS amortise over time, which de-risks them, and as a result they consistently get upgraded. This provides opportunities to generate total return even in a more range-bound benign market environment.