We analyze the treatment of European asset-backed securities (ABS) under the regulatory framework for Dutch pension funds (FTK). ABS loans are collateralized, leading to low expected losses. The overall required capital under FTK therefore decreases if ABS are funded with credits. At the same time, the expected return will typically increase. This makes an investment in ABS an attractive alternative to credits in the current low-yield environment.
In this article we provide more insight into the relative attractiveness of ABS investments, compared to other asset classes. Some stylized results are shown below for FTK, the regulation applicable to Dutch pension funds.
Figure 1: Impact of ABS on required capital and expected return under FTK. Source: Aegon Asset Management
These results show that the required capital can be reduced by substituting credits (or riskier assets) with ABS, see the (downward) green arrows in the first column. A capital-constrained pension fund can thus, for instance, free up capital by funding ABS with equities. At the same time, the expected return improves significantly when ABS are funded by credits (see the upward green arrows in the second row), making ABS a good alternative to credits in the current low-yield environment.
To summarize, we find that:
- Additional return compared to sovereigns or credits
- Low risk profile and low capital charge under FTK
- Attractive alternative to credits for Dutch pension funds