The Simple, Transparent and Standardised (STS) label was introduced in 2019 to stimulate activity in the ABS market. The STS framework applies significantly lower capital charges to eligible securities than the former ‘Type 1’ and ‘Type 2’ charges, and offers an attractive return on capital under Solvency II, with a yield pick-up over liquid short-dated corporates. The STS investment universe offers a robust and scalable market with the current outstanding market value exceeding £250bn.
The following outlines ways in which insurers can incorporate STS ABS into their portfolios. We highlight several of the most common themes.
Many insurers have been drawn to STS ABS because of the yield pick-up it offers over traditional credit and cash. STS ABS is often overlooked by investors as it can be more structurally complex to understand than other traditional fixed income options. This means investors in STS ABS can benefit from an attractive yield premium.
In a rising interest rate environment, some investors have been keen to reduce duration within portfolios. Given the floating rate nature of ABS, it can help act as a hedge in a rising rate environment.
At times of stress, many similar asset classes tend to become highly correlated. This has been the case with credit and government bond markets. European STTS ABS offers clients a degree of diversification versus traditional credit and government bonds.
As global markets swing from risk-on and risk-off, European STS ABS offers investors an opportunity to diversify their fixed income exposure.
The cash flows produced by STS ABS bonds are typically generated by the underlying consumers paying their mortgages, car loans and credit cards. These tend to follow a different cycle to sovereign and corporate markets, providing a different return profile for most portfolios.
Aegon Asset Management’s ABS team performs the ESG analysis of ABS by evaluating collateral data, engaging with ABS originators, and assessing the transaction structure and the country of the collateral. The analysis eventually results in an ESG score for each specific ABS transaction we assess, allowing us to avoid investing in bonds with a low ESG profile.
