Tuesday 01 May 2018 by Asmita Kulkarni Trade opportunities

Make the move to investment grade bonds with RMBS

Moving to higher quality investment grade securities is an ongoing theme for portfolios. RMBS looks attractive compared to similarly higher rated financial or corporate bonds

moving

Lately, we have been reiterating our view that clients should be moving into securities that are rated investment grade and have shorter maturities. Residential Mortgage Backed Securities (RMBS) have played a large part in this move to invest client funds in higher rated securities. As such, it’s timely to look at some relative value comparisons for RMBS as the rated tranches tend to trade at an attractive yield when compared to similarly rated financial or corporate bonds.

Figure 1 plots the yield of Class B (AA rated) tranches of the four most recent RMBS issues against the yield curves for Australian ‘AA-‘’ rated financials, ‘BBB’ rated financials and ‘BBB’ rated corporates. All yields are calculated based on market price.

It is likely that the extra complexity within RMBS accounts for the spread difference, specifically the fact that the principle and interest schedule is difficult to forecast. However, we continue to believe that the differential between the equivalent rated (corporate bond and RMBS) product makes RMBS look attractive. Additionally, despite spreads narrowing over the last six months, RMBS continues to offer strong relative value and can help diversify your portfolio.

As a reminder, major bank RMBS tend to trade the tightest, followed by issuance by larger authorised deposit-taking institutions (ADIs). For example, Bank of Queensland, Suncorp, AMP and credit unions, then non bank prime issuers like Firstmac and Resimac and lastly, the non conforming subprime issuers such as Liberty, Pepper, La Trobe.


Source: FIIG Securities
Figure 1

For more information on RMBS, please see this webinar, or click on the links below.