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COMMENTARY
The past few months have seen asset managers encouraging investors to look at securitised credit (MBS / ABS). Their pitch in a nutshell: diversification from conventional fixed income, healthy returns over the past 15 years (GFC aside), value in an “unloved” sector while traditional bonds are rich, and a complexity premium given that the instruments are famously difficult to value. Investors are told that pre-‘GFC’ problems in MBS have been addressed: reliance on credit ratings has decreased with more loan-level analysis and third-party due diligence; misaglined compensation practices in mortgage origination have been tackled by riskretention rules; loans are underwritten to a more conservative standard.
Yet there are notable headwinds in play. The Federal Reserve is beginning to unwind its Agency MBS purchases. Valuations are tight. The level of issuance in non-Agency RMBS remains low thanks to tighter lending standards and banks’ preference for agency loans in their portfolios, although shortage of supply can be positive for pricing. Interest rate volatility can be detrimental to for MBS performance, although the key relationship – that between prepayment risk and rates – is exceptionally hard to model.
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