Unsubscribe

Confirm you would like to unsubscribe from this list

Remove strategy

Confirm you would like to remove this strategy from your list

Welcome to Thornburg

Please select your location and role to help personalize the site.
Please review our Terms & Conditions

For Institutional / Wholesale / Professional Clients

The content on this website is intended for institutional and professional investors in the United States only and is not suitable for individual investors or non-U.S. entities. Institutional and professional investors include pension funds, investment companies registered under the Investment Company Act of 1940, financial intermediaries, consultants, endowments and foundations, and investment advisors registered under the Investment Advisors Act of 1940.

TERMS AND CONDITIONS OF USE

Please read the information below. By accessing this web site of Thornburg Investment Management, Inc. ("Thornburg" or "we"), you acknowledge that you understand and accept the following terms and conditions of use.

Disclaimers

Products or services mentioned on this site are subject to legal and regulatory requirements in applicable jurisdictions and may not be licensed or available in all jurisdictions and there may be restrictions or limitations to whom this information may be made available. Unless otherwise indicated, no regulator or government authority has reviewed the information or the merits of the products and services referenced herein. Past performance is not a reliable indicator of future performance. Investments carry risks, including possible loss of principal.

Reference to a fund or security anywhere on this website is not a recommendation to buy, sell or hold that or any other security. The information is not a complete analysis of every material fact concerning any market, industry, or investment, nor is it intended to predict the performance of any investment or market.

All opinions and estimates included on this website constitute judgements of Thornburg as at the date of this website and are subject to change without notice.

All information and contents of this website are furnished "as is." Data has been obtained from sources considered reliable, but Thornburg makes no representation as to the completeness or accuracy of such information and has no obligation to provide updates or changes. Thornburg disclaims, to the fullest extent of the law, any implied or express warranty of any kind, including without limitation the implied warranties of merchantability, fitness for a particular purpose and non-infringement.

If you live in a state that does not allow disclaimers of implied warranties, our disclaimer may not apply to you.

Although Thornburg intends the information contained in this website to be accurate and reliable, errors sometimes occur. Thornburg does not warrant that the information to be free of errors, that the functions contained in the site will be uninterrupted, that defects will be corrected or that the site and servers are free from viruses or other harmful components. You agree that you are responsible for the means you use to access this website and understand that your hardware, software, the Internet, your Internet service provider, and other third parties involved in connecting you to our website may not perform as intended or desired. We also disclaim responsibility for damages third parties may cause to you through the use of this website, whether intentional or unintentional. For example, you understand that hackers could breach our security procedures, and that we will not be responsible for any related damages.

Thornburg Investment Management, Inc. is regulated by the U.S. Securities and Exchange under U.S. laws which may differ materially from laws in other jurisdictions.

Online Privacy and Cookie Policy

Please review our Online Privacy and Cookie Policy, which is hereby incorporated by reference as part of these terms and conditions.

Third Party Content

Certain website's content has been obtained from sources that Thornburg believes to be reliable as of the date presented but Thornburg cannot guarantee the accuracy, timeliness, completeness, or suitability for use of such content. The content does not take into account individual investor's circumstances, objectives or needs. The content is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services, nor does it constitute investment advice and should not be used as the basis for any investment decision.

Suitability

No determination has been made regarding the suitability of any securities, financial instruments or strategies for any investor. The website's content is provided on the basis and subject to the explanations, caveats and warnings set out in this notice and elsewhere herein. The website's content does not purport to provide any legal, tax or accounting advice. Any discussion of risk management is intended to describe Thornburg's efforts to monitor and manage risk but does not imply low risk.

Limited License and Restrictions on Use

Except as otherwise stated in these terms of use or as expressly authorized by Thornburg in writing, you may not:

  • Modify, copy, distribute, transmit, post, display, perform, reproduce, publish, broadcast, license, create derivative works from, transfer, sell, or exploit any reports, data, information, content, software, RSS and podcast feeds, products, services, or other materials (collectively, "Materials") on, generated by or obtained from this website, whether through links or otherwise;
  • Redeliver any page, text, image or Materials on this website using "framing" or other technology;
  • Engage in any conduct that could damage, disable, or overburden (i) this website, (ii) any Materials or services provided through this website, or (iii) any systems, networks, servers, or accounts related to this website, including without limitation, using devices or software that provide repeated automated access to this website, other than those made generally available by Thornburg;
  • Probe, scan, or test the vulnerability of any Materials, services, systems, networks, servers, or accounts related to this website or attempt to gain unauthorized access to Materials, services, systems, networks, servers, or accounts connected or associated with this website through hacking, password or data mining, or any other means of circumventing any access-limiting, user authentication or security device of any Materials, services, systems, networks, servers, or accounts related to this website; or
  • Modify, copy, obscure, remove or display the Thornburg name, logo, trademarks, notices or images without Thornburg's express written permission. To obtain such permission, you may e-mail us at info@thornburg.com.

Severability, Governing Law

Failure by Thornburg to enforce any provision(s) of these terms and conditions shall not be construed as a waiver of any provision or right. This website is controlled and operated by Thornburg from its offices in Santa Fe, New Mexico. The laws of the State of New Mexico govern these terms and conditions. If you take legal action relating to these terms and conditions, you agree to file such action only in state or federal court in New Mexico and you consent and submit to the personal jurisdiction of those courts for the purposes of litigating any such action.

Termination

You acknowledge and agree that Thornburg may restrict, suspend or terminate these terms and conditions or your access to, and use, of the all or any part this website, including any links to third-party sites, at any time, with or without cause, including but not limited to any breach of these terms and conditions, in Thornburg's absolute discretion and without prior notice or liability.

Decline

Give Us a Call

Fund Operations
800.847.0200

FIND ANOTHER CONTACT
Investment Tactics

Think ABS Residuals To Improve Your Risk/Reward Trade Off

Selective ABS residuals may improve your risk/reward trade off in the fixed income portfolio construction process.

Introduction

One of the benefits of the securitized fixed income space is the diversity from which investors can access different sources of cash flow, as well as various structures to reflect their risk/return preferences. In this article, we explore asset-backed security (ABS) residuals, which represent the first loss (equity) tranche of a structured ABS deal. We will describe how ABS residuals function, what type of return and volatility they offer to investors, and how market participants can include ABS residuals in their fixed income portfolio construction process to enhance the portfolio’s risk/return tradeoff.

What Are ABS Residuals?

As mentioned, ABS residuals represent the first loss tranche of an ABS deal, meaning the residual will receive cashflow once the other tranches receive principal and interest. Therefore, any and all excess cash flow generated by the deal flows into the residual tranche. This begs the question: what comprises ‘excess cashflow’? Excess cashflow is generated in two ways. One is through overcollateralization, which occurs when the value of the aggregate underlying loans is larger than the debt underwritten in the deal. A simple example is a deal sized at $1 million but backed by underlying collateral worth $1.1 million. The second, and perhaps more prominent source of cash flow, is from what is called excess interest. Excess interest represents the difference between 1) the interest rate of the underlying loans and 2) the average interest rate paid to the individual tranches. In some cases, this difference can be quite meaningful, as the level at which an issuer can fund itself can be very different than the rate for the underlying collateral. For example, if a subprime auto deal pays out an average interest rate of 10% across tranches, and the underlying subprime loan borrowers pay 20% on their loans, the difference of 10% flows to the residual. This 10% figure assumes no underlying defaults, but the residual can still earn meaningful cashflow even if defaults occur.

An Example of an ABS Deal with a Residual Tranche

Source: Thornburg

Not surprisingly, given a residual’s cash flow structure, the yields – or more accurately, the internal rate of return (IRR) – can be extremely attractive. In many base case scenarios, residuals can earn equity-like returns, which no doubt makes them risky investments. That said, ABS residual cash flows were quite solid through the COVID crisis, as underlying borrowers remained largely resilient and continued servicing debt payments.

The Role of ABS Residuals in a Fixed Income Portfolio

ABS residuals can be a great return enhancer and fundamental diversifier in a multi-sector portfolio that consists of more traditional forms of risk, such as government, corporate credit, and sovereign credit. It’s important to be mindful of the context in which residuals may serve in a portfolio. Given its equity-like risk/return profile, we believe residuals should be sized as a relatively small allocation. Just as important, ABS residuals can play an effective role in generating return while keeping portfolio risk constant. Below is an example of how this can be achieved:

 

Source: Thornburg

Here, we use the example of how to deploy 1% of capital in a portfolio. One option is to buy high yield at an approximately 7% yield. Let’s assume that the worst-case scenario is that the high yield positions default with a recovery rate of 50%, meaning a total 50 bps of loss to the portfolio. We strongly argue that in this environment, it’s better to construct the position with 25 bps in the ABS residual while deploying the other 75 bps in higher quality securities. This strategy results in the same yield but with lower capital at risk (25 bps, assuming 100% loss in default) and access to what we believe is a fundamentally stronger prime consumer balance sheet versus the corporate balance sheet.

The broader markets have experienced elevated volatility so far in 2022, and concurrent to this trend, base case IRRs for ABS residuals have been rising to compensate for greater macro uncertainty. That said, we continue to be very constructive on the ABS residuals we hold in our portfolios, particularly in deals backed by prime consumers. These borrowers exhibit strong credit and payment histories even in adverse economic environments. Despite potential macro driven price volatility, underlying cashflows look to remain fundamentally strong given the robust underlying borrower characteristics. While markets and our outlook on ABS residuals will continuously evolve based on changing fundamentals and valuations, we believe ABS residuals present a unique part of the broader fixed income opportunity set that investors should learn more about and perhaps implement in their portfolios.

Discover more about:

Stay Connected

Subscribe now to stay up-to-date with Thornburg’s news and insights.
Subscribe

More Insights

Advising Clients

The Death of the 60/40 Portfolio? Think Again.

If investment print and internet article headlines give you anxiety, you've come to the right place. In this podcast, Jan shares ideas that may prevent your blood pressure from spiking the next time you read an alarming headline. Plus, the debut of the Ask Jan segment.
Global Equity

Navigating the Post-COVID Resurgence in Travel and Hospitality

As the storm that crushed the travel and lodging industries clears, we see post-Covid investment opportunities and pitfalls in the skies ahead.
Markets & Economy

Is the Fed Gambling with Markets & the Economy?

Jason Brady believes “We're not going to see anything near the Fed's 2% target inflation… forcing the Fed to continue to be very hawkish."

Our insights. Your inbox.

Sign up to receive timely market commentary and perspectives from our financial experts delivered to your inbox weekly.
This field is for validation purposes and should be left unchanged.
Feedback