With its growing availability and attractive spreads, the esoteric ABS market is creating new opportunities to enhance portfolios.

With tightening spreads in traditional ABS sectors such as Prime Auto and Prime Credit Cards, we believe tapping into the broader ABS market can create more efficient fixed income portfolios offering higher yield potential with comparable risk. In our view, the increasing availability of esoteric ABS offers a natural alternative to build higher yielding portfolios. The esoteric market has grown 33% in yearly issuance to $68 billion in the last two years. The largest issuance has been in Unsecured Consumer Lending ($16 billion), Franchise/Whole Business ($14 billion) and Aircraft Leasing ($8 billion). Currently, the combined size of esoteric sectors is around $131 billion, constituting 21% of the total ABS market.

From a relative value perspective, esoteric ABS can provide better value than the traditional ABS sectors. Sectors such as Timeshare, Private Credit Student Loans, Transportation Equipment and Whole Business offer attractive spreads and higher yields while having comparable durations and credit ratings.

For example, AAA-rated three-year Private Credit Student Loans (71 bps spread) compare favorably with traditional benchmark components such as AAA-rated three-year Prime Auto (31 bps) and Credit Cards (25 bps), as well as having attractive yields and spreads relative to the Bloomberg U.S. Corporate 1-5 Year Index (49 bps). A similar case can be made for other investment grade ABS sectors such as three-year A-rated Timeshares (96 bps) and five-year A-rated Shipping Containers (131 bps). This opens up the possibility of building more inclusive portfolios capable of achieving higher yields.

In our view, data appears to support the use of nontraditional ABS sectors in seeking to improve portfolio performance. Our optimization analysis conducted within the ABS market suggests that including nontraditional sectors may improve portfolio risk and return characteristics. Of these nontraditional sectors, we favor Private Credit Student Loans, Timeshares and Telecom Infrastructure assets for their high-quality consumer exposure, natural deleveraging characteristics and good underlying value supports.

While these esoteric sectors offer a very attractive alternative, we believe security selection is an important component of the return potential available from these opportunities. Therefore, thorough evaluation of credit and liquidity risk within these markets would be the crucial step in realizing these higher risk-return characteristics.

For more on this topic, please read Esoteric ABS: Current State of the Market and Selective Opportunities