Higher yield, lower rate risk - where ABS fits in a portfolio

This interview was filmed 15th October, 2026.

When Australians tighten their belts, the nice dinner out gets sacrificed well before the car loan does.

That pattern sits at the heart of asset-backed securities (ABS), bonds backed by pools of underlying loans - everything from mortgages, car loans and personal loans, rather than a single company.

They offer extra yield over corporate bonds - but it doesn’t come for free.

In a recent conversation, I spoke with Chris Whitcombe, lead portfolio manager of the Challenger Investment Management (CIM) Global ABS Fund, to simplify how these securities work, how they hold up under pressure, and where he’s finding value today.

Explaining ABS and how it works

A corporate bond is a loan to one company. An ABS bond is backed by a portfolio of loans, which can number in the hundreds or thousands.

“Typically, you think of ABS and you think of mortgages, but actually the ABS universe covers all sorts of underlying collateral from mortgages to auto loans to unsecured loans and corporate credit,” Whitcombe says.

The defining structural feature is tranching. Each deal is split into layers, from senior down to junior. 

The senior tranches are paid first as interest and principal come in, while any losses hit the junior tranches first - like a waterfall. That gives senior holders a buffer.

Other protections can include extra collateral, reserve accounts and “excess spread” - this is the gap between the income earned on the loan pool and the income paid out to bondholders. 

All of these help absorb losses before they reach the bonds.

What makes ABS different 

The key distinction between ABS from fixed income and corporate bonds, as Whitcombe explains, is the risk underneath.

“With ABS, you’re taking a diversified exposure to a diversified pool with different risk factors,” Whitcombe says. “Typically, you’re taking exposure to consumer payment behaviour rather than corporate credit.”

That means an ABS allocation in your portfolio is a bet on whether households keep making repayments, not on whether one company stays solvent.

Assessing the quality of the loans

Whitcombe uses a four-part process.

"If you think about a securitisation, you have both a collateral structure and an originator to review." Whitcombe explains.

First, he reviews the lender, including who it lends to and how it approves loans. Second, he looks at the borrowers, and how much debt they carry and whether they’re able and willing to repay. Third, he checks the collateral and how losses would be recovered if a loan goes bad. And fourth, he looks at the portfolio as a whole for concentrations in a single borrower, region or industry.

He cautions against relying on averages.

“Often there can be tails of the portfolio where you have more highly leveraged borrowers or specific property types or collateral that have layered risk in the portfolio,” he says.

Then comes the structure itself, meaning the rules that decide who gets paid when. 

“Understanding the borrowers, the portfolio and the structure is key within the securitisation.”

When the economy slows

In a downturn, Whitcombe expects the warning signs to show up in the loan data.

“If we see a slowdown in the economy, you’d expect to see that come through in terms of increases in arrears, increases in defaults and changes in prepayment rate behaviour.”

Another surprising signal is repayment speed. “Sometimes you can have real impacts by increases or decreases in prepayment rates or repayment rates of the portfolio that can impact different bonds differently in the structure.”

There is also market risk on top of credit risk. “If you see an increase in perceived risk in the market, you could see widening in credit spreads. That could also come with illiquidity as well.”

For Whitcombe, it comes down to interrogating that data.

"Looking at how borrowers have behaved in the past in different economic conditions, and then stress-testing how it could behave in the future gives you a good idea of the sensitivity of the portfolio to changes in economic conditions."

Households under pressure

With borrowing costs weighing heavily on households, I asked how worried he is about defaults. Whitcombe pointed to how borrowers have behaved in past rate and inflation cycles, cutting discretionary spending as the first course of action.

“The mortgage or the auto payment or your loans or credit cards tend to be your first priority payments rather than going out for an extra dinner or buying a new car.”

Whitcombe puts jobs ahead of property values as another signal to watch. 

“I think other aspects such as house prices are key indicators, but often they’re less important than other wider indicators such as employment rate or ability to pay the mortgages as well.”

The extra yield isn’t free

ABS can play two roles in a portfolio. 

First, Australian and European ABS are mostly floating rate, so although their income moves with short-term interest rates, their prices are far less sensitive to changes in market interest rate expectations than traditional fixed-rate bonds.

Second, they tend to pay more. “If you look at it on a rated basis, the ABS tends to have a higher credit spread versus similarly rated corporates," Whitcombe pointed out.

The extra return is not without risks attached. “One of the key things is you shouldn’t think of that additional yield as free return, but you can really decompose that into different risk factors.”

Those risks can include:

• Credit risk: the bond is impaired or downgraded.
• Structural risk: the payment rules behave differently as conditions change.
• Prepayment risk: cash comes back sooner or later than expected.
• Liquidity risk: the bonds can be harder to sell, especially when markets are stressed.

Where are the opportunities?

Whitcombe’s main focus is the higher-quality end of the market, deploying selectively into highly-rated floating rate opportunities.

He is also sees opportunities in the secondary market, which benefit from having more data available. “In those markets, you can tend to have a little bit more visibility on the exact payment behaviour of the underlying portfolios because those have been outstanding for longer.”

Older deals can also become safer over time as borrowers pay down their loans and the protection beneath senior tranches grows. Something charmingly called "seasoning".

Whitcombe sees the asset class as a long-term opportunity rather than a short-term trade, but not one for every investor.