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By Keith Nguyen - November 16, 2018
ABS (asset-backed securities) aren't your grandparents' bonds. They aren't issued by the federal government, like Treasury bonds, or by state and local governments, like municipal bonds. Instead, ABS are bonds that are put together ("securitized") from consumer and other loans, such as student debt and auto loans, among others. The relatively smaller universe and complex structure often make ABS an overlooked asset class, which provide attractive income relative to the interest rate risk they bear. In today's rising rate environment, ABS may deserve an allocation in your fixed income portfolio. Due to high valuations and tight spreads across many asset classes, we encourage investors to seek out experienced investment managers who have demonstrated solid track records of investing in this niche area.
ABS are supported by a pool of income-producing assets. Underlying assets range from auto loans, student loans and credit card debt to esoteric segments such as aircraft, railcar and shipping container leases. ABS securities are then divided into smaller pieces (tranches) with different rating or risk profiles and sold to investors. Skilled bond managers can add value by picking the attractive tranches. Lenders typically collect payments from underlying loan borrowers and flow these interest payments to ABS investors.
Subprime auto loan ABS offer attractive yields and are good for portfolio diversification because their performance tends to be uncorrelated with the stock market. However, there have been a few recent headlines about rising delinquencies among auto loans, highlighting the importance of credit analysis.
We believe that consumer credit fundamentals are quite good, and that fears of a possible bubble in subprime auto loans are likely overblown. Nevertheless, these sorts of concerns remind us that credit research is required in ABS land, especially in the later stages of an economic cycle.
Read our primer on ABS to learn more about this attractive asset class located just slightly off the traditional bond investor's beaten path. Or, dig into our insights on subprime auto loans ABS specifically to hear our views on this frequently-cited space.
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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.