Relative to the pre-COVID period, public asset-backed securities continue to offer a meaningful spread pickup vs. similarly rated corporate bonds. In our view, this excess premium largely reflects lingering concerns about the relative health of U.S. consumers compared with corporations. Indeed, delinquency rates on auto loans and credit cards have been hovering near recession-like levels, whereas measures of financial stress among public corporate borrowers—such as defaults and rating migrations—remain broadly benign.

We view this excess premium as an attractive source of carry, particularly in the context of rich valuations in corporate credit markets, a constructive forward outlook for the U.S. consumer, and the structural protections embedded in ABS—most notably the subordination levels that help absorb potential losses. Historically, cumulative loss rates on these products have stayed meaningfully below attachment points for IG-rated tranches.

Asset-backed securities also appear attractive relative to corporate bonds when benchmarked against the pre-Global Financial Crisis period. A common narrative is that this cheapness is justified, given that the run-up to the crisis was characterized by artificially tight spreads in structured products. But this view overlooks a critical nuance: today’s ABS structures are significantly more robust than those issued before 2010, with stronger underwriting standards and higher levels of subordination that provide greater protection against losses.

Corporate bond yields are somewhat elevated, currently sitting at their 65th percentile value in the last 20 years of trading. Meanwhile, corporate bond spreads are near their tightest values over the same time period. In fact, only seven trading days in the last 20 years have closed with lower spreads than the end of last week. While this phenomenon may be relatively unproblematic for all-in yield buyers, spread buyers are a different story.

Asset backed securities (ABS) represent a securitized pool of cash flowing assets, typically with a multi tranche structure to allow investors to find their optimal risk level while staying within the same pool of assets. While ABS can be structured from almost any underlying pool of cash flows, the most prevalent ABS are structured from pools of consumer debt, such as auto loans, credit cards, and personal loans.

To get a better idea of the actual spread pickup offered by ABS in the current market vs. corporate bonds, we examine the new issue spreads offered by ABS products year-to-date. On average this year, A-rated ABS have offered a spread pickup of 90bp over A-rated corporate bonds on the day of pricing, with a median pickup of 74bp.

While not cheap at an index level, European credit and emerging market (EM) debt also offer opportunities, with dispersion remaining elevated across both markets. EM debt, in particular, is showing signs of a comeback after being out of favour for several years. We believe they also offer strong alternatives to a broadly expensive US IG credit market.

In both European and emerging market credit, we are observing greater dispersion, with inter-decile spreads notably wider than their US counterparts. This creates opportunities for active managers to distinguish between companies genuinely facing challenges and those being unjustifiably penalised.

In addition, EM corporates are in better fundamental health than their US counterparts. Balance sheet leverage for the former has reduced significantly since the COVID pandemic, resulting in a more diverse and fundamentally sound market that is yet to be fully reflected in valuation metrics.

In the case of Europe, fiscal spending may serve as an additional tailwind for European credit. Earlier this year, Germany announced the largest economic stimulus since the aftermath of the fall of the Berlin Wall. Should this spending materialise, Europe may find new momentum through its largest economy’s fiscal expansion which we would also expect to provide meaningful support for European corporate earnings. A surge in M&A in the European banking sector is creating additional opportunities for investors, alongside continued demand for significant risk transfers (SRTs) as banks seek to improve their return on equity.

Summary: The US credit market represents more than 60% of global credit indices, but may not be where the best opportunities present, in our view. ABS, European and EM credit not only offer avenues for diversification but may warrant greater attention from investors owing to supportive technicals, better fundamentals and the opportunities created by dispersion.