Goldman Says Investors Should Rotate Into Securitized Debt From Corporate Bonds

(Bloomberg) -- Rising inflation in the U.S. could end up being much better for consumers than for companies, so investors should be rotating out of corporate bonds and into asset-backed securities and other securitized debt, according to strategists at Goldman Sachs Group Inc. 

Supply-chain disruptions are likely to limit corporate profits next year, which could hurt company debt, while pushing home and car prices higher, helping securities backed by those assets. Meanwhile wage inflation pressure that many companies are seeing will weigh on corporate profit while helping consumers, wrote Goldman Sachs strategists led by Marty Young and Lotfi Karoui. 

Also, valuations look better in securitized bonds than for corporate bonds on a historical basis, the strategists wrote. For example investment-grade corporate bond spreads are in their fifth percentile for their tightness over the last five years, while AAA collateralized loan obligations are at their 14th percentile. 

“The macro setup appears to be more supportive for securitized than for corporate credit,” the Goldman Sachs strategists wrote. 

Goldman economists expect the unemployment rate to move down to 3.5% by the fourth quarter of 2022, and for U.S. wage growth to head up toward 4% annually, with even stronger growth for lower wage workers. This will likely eat into corporate gains, but will be a tailwind to any type of ABS linked to consumer payments, including auto, student loan, credit card, residential mortgage credit, and consumer-loan-backed securities, the strategists wrote.

Similarly, supply chain disruptions which have been constraining auto manufacturer and homebuilder production volumes and profits have, at the same time, helped boost used vehicle and home prices, which are up 38% and 20% year over year, respectively, the strategists said. 

Auto ABS loss rates are currently at multi-decade lows, in part reflecting record high recovery rates on repossessions, the strategists wrote. Even asset-backeds tied to companies, such as equipment ABS backed by loans and leases for office, manufacturing, and agricultural machinery, and container ABS backed by leases of shipping containers can benefit from price inflation pressures caused by supply chain challenges.

“Securitization products have historically offered diversification benefits versus corporate credit,” the strategists wrote. “While diversification motives alone are sufficient, we think, to justify allocating to securitized sectors at present, relative value considerations are also supportive of rotation away from corporate credit and towards structured credit given current valuations.”

Relative Value

Securitized-debt has had a blockbuster year of sales, with post-2008 financial crisis supply records already set in most sectors, including ABS and CMBS. Collateralized loan obligation sales, already at an all-time annual record, look poised to accelerate into the end of the year.

Many parts of the securitized market, such as collateralized loan obligations, and some student-loan ABS, are floating-rate, which is alluring during a time when rates are projected to increase.

“Securitized debt is attractive versus short-term corporate debt on both a spread and yield basis,” said Daniel Lucey, a senior portfolio manager who invests in securitized credit at SLC Management. “CLOs, for example, are a great structure in a rising rate environment.  We are overweight CLOs -- especially single-A tranches -- everywhere in our portfolios.”

Relative Value: Agency MBS 

• Goldman Sachs Asset Management has transitioned from to an underweight position in agency MBS from neutral, according to its latest weekly fixed income report.
• Analysts anticipate relatively stable supply accompanied by $5 billion monthly reductions of MBS purchases by the Fed to be a headwind for the sector
• Additionally, recent outperformance within the sector amid rate volatility prompted GSAM’s decision to pull forward re-entering an underweight position

Quotable

“There has been a little bit of sloppiness developing in some stable ABS sectors including recently issued subprime auto and student loan paper,” said Dave Goodson, head of securitized credit at Voya Investment Management, speaking about pricing for new offerings. “Issuer tiering is beginning to re-emerge.”

What’s Next

ABS deals in the queue include Oak Street (triple net lease ABS), Capital One (credit card), and FirstKey (single family rental)

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