The asset-backed securities market, already hit by shrinking supply as consumers have reined in spending, is facing yet another problem: declining demand as investors migrate to other markets in a quest for greater returns.
With fewer consumer loan-backed bonds on offer, investors have bid up prices and driven down yields, which move inversely. Those lower returns have led some portfolio managers to say they are looking for value in other parts of the bond market.
Other portfolio managers are moving out of these bonds to reflect their diminished share of fixed-income indexes. Many managers' performance is compared with such indexes, and strategists said they would likely reduce ABS holdings to parallel their share of the benchmarks.
In the Barclays Capital U.S. Aggregate Index, for instance, the market value of ABS securities declined to 0.27% at the end of October from 1.17% on Oct. 31, 2006, before credit markets fell apart.
That figure was 0.38% at the end of October 2009.
"A year ago, I was paying closer attention to ABS because it was a great sector to be in and had collateral you could be comfortable with," said Arnold Espe, a vice president at USAA in San Antonio, who co-manages about $3 billion in three fixed-income funds.
Now, Espe said, he can "pick up better value elsewhere" as he seeks higher total returns. Currently, Espe has about 2% of his holdings in ABS, down from 10% a year earlier.
In order to prevent a migration out of the asset-backed bond sector, issuers will have to put together deals that provide higher return at an acceptable level of risk, industry participants said.
Triple-A-rated bonds backed by auto loans and leases, which make up 60% of issuance this year, have lost 0.30 percentage point of their premium over super-safe Treasuries in the past 52 weeks. Similarly high-rated credit card-backed bonds are considered stable, but offer little additional yield. Bonds backed by unusual collateral like billboard revenue or franchise loans could offer more yield.
Buyers will have to figure out whether it makes sense for them to invest in these bonds at current valuations, keeping in mind what's best for their portfolios.
There was a "window of some months" when it made sense to buy asset-backeds, said Jason Weiner, a senior fixed-income fund manager for M&I Investment Management Corp. in Milwaukee.
Weiner said he had invested in asset-backed securities but "currently valuations are full." He now sees better value in corporate bonds, and is no longer shopping in the asset-backed market.
Still, portfolio managers may look at ABS and say the trade has worked out well and there may be other areas to consider where they could get better value. "Generic consumer ABS is a good place to park cash," said Joseph Astorina, a strategist at Barclays Capital in New York. Compared with high-yield bonds, there is still value in residential and commercial mortgage-backed securities, he said.
Asset-backed securities are "highly liquid and the returns are better than having holdings in cash," Astorina said, adding that spreads are close because of the "strength of consumer ABS."
"It commands tight spreads," he said. "It performed well throughout the crisis."