The ABS investor has seemingly evolved into a credit-savvy creature wary that structure does not always protect investments. Speaking at Information Management Network's ABS East, the Uncovering Relative Value in the Public Markets panel discussion showed how far institutional money managers have come in recent years.
While United Capital Market's President John Devaney caused a stir in the day's opening general session, institutional investors described a more cautious approach to buying ABS. While there are some short-term opportunities in the ABS market, a buy-and-hold investor must earn his or her return via a hands-on approach and due diligence. This is not a new theme for the buyside, but now it is a mantra.
Investing in distressed and off-the-run assets, hoping to gain on market fluctuations, described as the "Devaney strategy," is not prudent for those managing insurance and pension funds, all agreed. That being said, investors claim they focus on the strength of servicer and macroeconomic trends more heavily than ever.
"If you think that a triple-A [ABS] is like a Treasury, you are sorely mistaken," said Deutsche Asset Management's Jim Grady. All on the panel of nine portfolio managers recommended that investors avoid off-the-run and distressed assets. There are risks, however, in even the most commoditized of asset classes, such as the technical aspects of supply and demand as well as asset performance in the current economic environment.
While the leading risks of increased interest rates and continued economic underperformance are understood, there are strategies available to mitigate these risks. Mortgage lenders, which have flooded the primary market with refinanced and subprime mortgages in the past two years, are seen as having strong credit underwriting programs and thus the underlying collateral performance is not seen as deteriorating.
Alliance Capital's Amy Boothe noted that the increased origination in the mortgage sector has been primarily rate-driven, adding that she "is not mindful of performance down the road." There may be risks going forward, however, as lenders scramble to maintain originations and bolster their share prices. "Performance may become a problem," Boothe added, " as rates increase and lenders reach for origination volume."
Performance triggers built into mortgage ABS may also present a problem, as extension risk may result from triggers lengthening the tenor of bonds. "A tripped trigger can turn a five-year bond into a seven-year bond, and investors are not compensated for this risk," Deutsche's Grady.
This extends into the auto-loan sector, he added, noting the triggers within the recent Whole Loan Auto Trust 2003-1 transaction issued by Bear Stearns are "pretty tight."
FICO scores should remain stable, most believed, and losses are not seen spiking in the near term. This bodes well for loss severities, according to Arturo Balana of The World Bank, as uninsured pools have seen severities decline to under 30% from roughly 50% in 1997. This was attributed primarily to increased home valuations and better loan-to-value ratios.
The bulk of the opportunities for total-return-fund managers remain in the secondary market for mortgage ABS through year-end. Laura Ladewski of Asset Allocation & Management Co. noted the yearly fourth-quarter widening in the mortgage sector that offers opportunities for the total-return investor. Within mortgages, Alliance Capital's Boothe recommended floating-rate paper.