EUROPE - Almost e92bn of new asset-backed debt has been sold into Europe so far this year, according to Deutsche Bank, indicating that the market sector is becoming increasingly popular among investors.

Falling equity markets and company credit ratings have made investors increasingly risk-averse, and asset-backed securities are among the safest of financial instruments. In support of the growing popularity of asset-backed securities, S&P, maintain that European collateralised debt obligation (CDO) pools are expanding beyond bonds and loans so as to accommodate investor needs.

At the S&P European CDO roadshow this week, S&P analyst, Katrien Van Acoleyen, explained that the managed synthetic CDO market is rapidly growing in the number of types of different investment instruments on offer.

“The CDO market (where investment-grade securities are backed by a pool of bonds, loans and other assets) can be extremely useful for investors. It allows them to specify the exact level of risk that they want to take, and in that sense it can be an interesting alternative to investing in straight corporate bonds. CDOs enable investors to take exposure to corporate credit risk as an asset class without the cost of establishing a credit team”, says Toby Nangle, portfolio manager at Baring Asset Management.

“The higher rated tranches are over-collateralised and can be constructed with an exceptionally low level of risk. They do however offer additional yields over government bonds”, adds Nangle.

CDOs are split into tranches according to credit rating, the lowest rated tranche being the riskiest and therefore the highest yielding. The lowest tranche is made up of equity underlying assets, and investors in such a tranche, for example hedge funds or banks, will be first to lose their money in the event of a company going bust. The super senior tranche will be rated Triple A and compare to a government bond, and are most popular with large insurance companies, but other investors should perhaps also be considering the attractions.

Says Mark Watts, deputy head of fixed income and head of the CDO asset management team at Baring AM: “Among pension funds, CDOs comprise only a very small part of a fixed income allocation, but they are instruments that should be considered. By getting involved in the higher rated tranches, pension funds could receive a spread above Libor. CDOs can add diversification to a portfolio. As investors in the low-rated equity tranche of the CDO take the first losses, pension funds have a higher degree of protection than they would otherwise have got from direct investments in corporate bonds."

The only drawback of CDOs is their illiquidity. CDOs tend to be bought and held, unlike other traditional assets which are can be traded regularly. But says Watts: “the market is innovating at a rapid rate. There are more and more broking houses which will put a price on CDOs, and this is sure to develop further.”

Keith Swabey, vice president at JP Morgan Chase Fleming AM, expects the asset-backed securitisation market as a whole to grow. “As people become more familiar with the instruments, the popularity will increase. The market can seem complicated, but with experience investors’ fear of the unknown will decline.”

France, Italy and the UK are currently the predominant players in the asset-backed market.

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