Aegon AM: Navigating volatility - the case for ABS opportunities
In the first half of 2025, the ABS market has done an excellent job in the face of uncertainty, and we think it will continue to demonstrate its resilience for the rest of the year.
Its strong performance occurred against a backdrop of high volatility stemming from the disruption instigated by US trade policy, rising geopolitical tensions, the escalating conflict in the Middle East, the impact of inflation and the related central bank’s policy setting.
As it stands, there remains limited clarity of what the impact will be and if the US will still implement the delayed tariffs. Furthermore, interest rates and geopolitical risks all present challenges for the global economy, sentiment and the impact on businesses and consumers.
Consumers started the year in a strong position: household net worth and savings rates remain strong, there is less uncertainty on where interest rates might go, at least in Europe, and the unemployment rate remains low on a historical basis. However, the US imposed (delayed) tariffs on global trade will have their effect on various parts of the global economy. Consumers are expected to face headwinds, with those in the US likely to be more affected than Europeans.
For corporates however, the effects are different, and we expect the impact on European corporates to be more significant. So far, inflation reports have shown minimal impact. However, certain corporate sectors, particularly those that generate most of their revenue from exports to the US, are beginning to feel some pressure.
Despite the widening we’ve seen in mid-April, there has been spread compression across the capital structure over 2025. Most sectors are either flat or tighter compared to the start of the year. We do not expect much further tightening, and with the credit curve compression observed over 2024 and in 2025 so far, there will be limited room for it. Relative valuations are still attractive, in particular sub-investment grade ABS spreads widening to their historical average.
As such, carry will continue to be the main driver of returns. While some deterioration is expected to occur in underlying exposures of ABS, structural protection such as excess spread and subordination is sufficient to withstand an increase in losses.
Therefore, due to their higher spread, CLOs (Collateralized Loan Obligations) will remain a significant part of our portfolio. Looking at market issuance, we expect consumer and auto ABS issuance will continue to be plentiful and risk/return characteristics to be attractive.
The fundamental outlook for consumers and the European economy is more favorable than for the corporate sector overall, suggesting that consumer-focused exposure is likely to outperform. The floating rate nature of ABS bonds also contributes to less volatile returns.
Considering the uncertain geopolitical environment we are in, high carry and low volatility will once again be the holy grail. Combined with some tightening potential at the sub-investment grade of the capital structure, ABS Opportunities seems to be the right fit at present.
