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Aussie RMBS and European banks stand out amid ‘expensive’ US fixed income

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By Oksana Patron
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4 minute read

Fixed income investors can find more attractive opportunities in Australian and European credit markets as US fixed income appears expensive, according to a portfolio manager.

Specifically, Australian residential mortgage-backed securities (RMBS) and European banks stand out, especially as the American market experiences uncertainty and tight valuations, according to Perpetual’s portfolio manager Vivek Prabhu.

Prabhu noted that Aussie RMBS, which pool thousands of home loans, allow investors to “capture returns from Australians’ love of housing without lending directly to individual borrowers”.

“I’m rotating into the high-quality end of the spectrum at this part of the credit and economic cycle. That’s where you’re currently being paid for risk,” Prabhu stated, adding that Australian residential mortgage-backed securities met his definition of a high-quality asset.

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He highlighted the strong track record of Australian RMBS, which have historically performed well and avoided losses even during the global financial crisis (GFC) and the pandemic.

Moreover, Prabhu noted that this asset class is supported by a combination of favourable current conditions and a strong historical performance record. He added that low unemployment and interest rates nearing the peak of their cycle have enabled individuals to service their mortgages effectively.

Perpetual also believes that unusually strong property prices, driven by high immigration, further bolster the investment case for this asset class.

“That means the collateral backing for these bonds, in terms of home owners’ equity, is supportive as well,” Prabhu added.

European banks

Meanwhile, well-regulated and stronger European banks present another attractive credit opportunity, according to Prabhu.

The improved profitability of Euro banks has been bolstered by stronger regulations and liquidity requirements imposed after the GFC, as well as the normalisation of interest rates.

“I’ve got close to 30 per cent of my portfolio in foreign bonds, largely allocated to European credits which are still offering good value compared to the expensive US market,” he said.

Prabhu stated that both Aussie RMBS and Euro banks are where investors should shift their focus, as credit spreads in the US have reached historic lows and the prospect of falling interest rates is driving demand for higher yields.

“I haven’t held any US banks in the portfolio for about 18 months now,” he said.

“That is not driven by any concerns around credit fundamentals – it’s just that I’m finding better risk-return propositions elsewhere.”

Commenting on the US election, he highlighted that a Trump clean sweep of the House and the Senate would likely be inflationary with tax cuts and tariffs.

“That means interest rates stay higher for longer, which is a headwind for risk assets,” he said.

“Having said that, if the Democrats get in, they also have some big spending policies.

“Deadlock might be the best outcome for markets – with neither side having a clean sweep of the Senate and the House.”