Investors looking to get exposure to a diversified product and those who don’t take the ups and downs of the market well would be well-served by considering asset backed securities as a component of their investment strategy. Their particular attraction lies as a tool to manage risk.
What Are Asset Backed Securities?
Asset backed securities are bonds based on an underlying pool of assets. They are a useful tool to manage risk and therefore attractive to risk-averse investors. With this type of securities, a special purpose trust or instrument is set up to take title to the assets, and pass the cash flows through to the investors in the form of asset backed securities. The types of assets that can be “securitized” range from residential mortgages to credit card receivables, and because the investment is spread across a number of assets, the risk to the total portfolio is reduced if one falls below the others.
Since these securities are based on assets, they can also be grouped together and invested collectively along with other asset backed securities in ways that would be difficult to do traditionally.
Assets of Asset Backed Securities Securitization
The underlying pool of assets that makes up these securities is usually illiquid and private in nature. A securitization occurs to make these assets available for investment to a much broader range of investors. The “pooling” of assets is meant to make the securitization large enough to be economical and more diversified.
The wonder of securitization is that it takes a wide variety of formerly illiquid and directly held assets and makes them available to many investors in the form of asset backed securities. This simple process can be applied to all sorts of cash-flow-producing assets. If a retailer needs cash, it securitizes part of its outstanding credit card balances from its customers into a “credit card receivables trust.” An auto-leasing firm takes the outstanding automobile lease balances and turns them into an “auto receivables trust.” A bank takes a group of its higher quality customers and creates an “evergreen revolving financing trust” which constantly takes high quality receivables and finances them by issuing bonds from the trust.
Administration of the pool of assets of asset backed securities is more systematic. The same “servicing agent” may collect all the monies from all assets and “pass it through” to the investors via a central trustee. We can have the payments made to the investors at the same date each month. We can even supply aggregate data and statistics on the pool to investors, such as the “Weighted Average Coupon” (WAC), or “Remaining Amortization” (RAM).