Asset-Backed Security (ABS)
Candlefocus EditorSecuritization is the process through which a large pool of loans or other types of debt are packaged into a tradable security. Straight securities, such as bonds, represent a promise to pay, while asset-backed securities are more complex because they are secured by a related asset or pool of assets. This backing makes them less risky than non-secured securities, generally allowing them to earn higher yields than other debt investments.
The issuing company (or originator) first pools its receivables and creates a contractual agreement, which specifies the rights and obligations of the seller, buyer, and servicer. It then sells these assets to a special purpose vehicle (SPV), usually to an asset-backed issuer, who issues the ABS to generate funds.
This type of investment involves higher overall risk than Treasury bonds or corporate bonds, but also yields higher returns due to diversified portfolio of financially strong assets. The return is also mostly dependent on the credit quality and performance of the underlying assets, as well as the reliability of the issuer. ABSs are often used as an alternative to lending and can be a great addition to a diversified portfolio.
Overall, asset-backed securities (ABSs) are an attractive debt instrument that can offer decent returns while also allowing investors to spread the risk of their portfolio. They are most suitable for investors with high risk tolerance, as the returns depend heavily on the reliability of the receiver, the quality of the asset, and the performance of the ABS over time.