Yield, resilience and diversification: the ABS opportunity

Europe continues to outperform the US

European structured credit remains structurally different to its US counterpart; the misconception that it mirrors pre-2008 US sub-prime debt still exists, which does not hold up under scrutiny. We believe this provides an opportunity for investors. Weighted average one year default rates in Europe have been consistently and substantially lower than in the US, as shown in the bar charts. This is supported by various factors which exist within the European securitisation market, which are less prominent in the US markets, including:

• Mandatory 5% risk retention requirement: banks and non-bank lenders are required to retain 5% of the risk on their balance sheets when portfolios of loans are sold into an SPV, aligning their interests with investors.¹
• Full recourse mortgage debt: if a borrower cannot meet mortgage payments, the lender can repossess and sell the property. If the proceeds do not repay the mortgage in full, the borrower remains liable for the shortfall, unlike in parts of the US where borrowers may hand back the keys.
• Stronger social safety net: government support can help borrowers to continue to meet mortgage payments during periods of economic stress or following changes in individual circumstances, including redundancy or health issues.

Post COVID, European collateral has continued to show minimal defaults, while the US has seen a noticeable increase in idiosyncratic developments.

Why are investors attracted to the asset class?

Attractive all-in yield

Investors can currently earn an attractive all-in yield relative to equivalently rated corporate bonds, reflecting a persistent spread pick up across the investment grade ABS market. We believe this premium is a function of technical and regulatory factors rather than compensation for higher credit risk, driven by three reasons:

• Harsh capital treatment: capital charges to hold ABS for banks and insurance companies are far higher than for corporate, covered or government bonds, which moderates demand for the asset class.
• Onerous regulatory burden: ABS investors are required to fulfil extensive due diligence and stress testing requirements, and these barriers to entry limit the ability of new investors to enter the market quickly.
• Complexity premium: ABS is a specialist asset class that requires detailed knowledge, and therefore trades with additional spread to account for this complexity.

Credit resiliency

This resilience is evident in stress testing. Using a typical AAA rated UK residential mortgage-backed security  (RMBS) bond, house prices would need to fall by roughly 40% with no recovery, alongside more than 70% of borrowers defaulting, before senior investors lose the first penny of principal. For context, the largest historic drawdown in UK house prices was around 20% during the Global Financial Crisis, and the peak 12 month repossession rate was 0.79% in 1992, a period where we saw very high interest rates and unemployment rates. Therefore, we would need to see a materially worse economic environment before we experience the very first penny of loss, and not a full write down, on the AAA tranche of a UK RMBS transaction.

Superior ratings stability

European ABS has a superior ratings migration track record to corporate bonds in every year over the last decade, with upgrades consistently outnumbering downgrades. Even during the onset of COVID-19 in 2020 the asset class saw almost twice as many upgrades as downgrades, and through the high inflation and rate normalisation of 2022 and 2023, its positive migration was vastly superior to the, on average, negative ratings movements seen in corporate bonds.

Diversification

ABS is predominantly secured on consumer, rather than corporate, collateral, therefore it exhibits low correlation with other established asset classes, materially lower annualised volatility, and a higher proportion of positive monthly returns throughout the market cycle, compared to traditional asset classes within a client’s portfolio. Combined with its floating rate nature, ABS can act as a defensive, income-generating allocation through periods of economic weakness or uncertainty.

Broad and diversified primary market

The technical backdrop is currently supportive across both the primary and secondary markets. Primary issuance across European ABS has been robust, providing a broad and growing opportunity set spanning residential mortgages, consumer loans, autos and collateralised loan obligations (CLOs), and a steady flow of new deals allows portfolios to be built selectively where valuations are most compelling. The secondary market is equally well established, benefiting from a deep and active investor base, daily trading and typically T+2 settlement, with the most common trading format being an auction process known as a Bid Wanted In Competition (BWIC) alongside frequent bilateral transactions. This depth provides genuine liquidity through the cycle, and given our long standing presence, scale and reputation, we are seen as a key counterparty, trading with in excess of 30 different counterparties during 2025. The investor base has also broadened materially in recent years as allocators have sought the yield pick-up, floating rate income and diversification the asset class offers, which continues to support both demand and orderly trading conditions.

Why M&G for ABS

Putting significant capital to work in the ABS market requires depth of resource and experience. M&G has actively managed structured credit as a standalone asset class since the late 1990s. With a dedicated research function established in 1999, a track record through Brexit, COVID, the Russia and Ukraine conflict and the UK Liability-driven Investment (LDI) crisis, as well as best-in-class proprietary tools and systems, we have an established a compelling platform to understand and invest in this market effectively:

• Scale and heritage: one of the largest structured credit platforms in Europe, with a dedicated portfolio management team including origination specialists, supported by a substantial team of dedicated research analysts.
• Independent, research led process: credit research and portfolio management are two independent functions. The role of the credit analysts, which we describe as career analysts, is to rank originators and conduct line by line analysis of underlying collateral to produce a fundamental credit view and an M&G credit rating.
• Wider resources: structured credit sits within a large fixed income platform, alongside corporate, financials, property and sustainability analysts, allowing genuine cross asset analysis of both collateral and structure.

Proprietary systems allow the entire holdings universe to be monitored and re-underwritten in real time, reassessing credit strength and relative value and comparing structures, collateral and counterparties side by side. This long standing presence, scale and reputation support strong primary and secondary market access, and the ability to be selective and add risk only where valuations are compelling.