ABS: A portfolio diversifier for volatile times

With the Middle East conflict clouding the outlook for inflation and interest rates, TwentyFour Asset Management’s Doug Charleston explains why asset-backed securities (ABS) could be a valuable diversifier for fixed income investors looking to deal with further volatility.

The early part of 2026 has been dominated by geopolitical risk and volatility. The US-Israeli war with Iran forced investors to price out expected interest rate cuts, sparking a broad sell-off across risk assets.

While markets have staged a steady recovery post-ceasefire, further talks have stalled, and with Brent crude oil having again risen well above $100 per barrel, the growth outlook remains deeply uncertain. Many investors will be looking for ways to protect their portfolios from further volatility as the year progresses.

In this environment, there are several features of European ABS and collateralised loan obligations (CLOs) that we believe make them a valuable diversifier for fixed income investors.

ABS and CLOs have virtually zero interest rate risk

One important feature of both ABS and CLOs is that they are primarily floating rate markets, where coupons automatically adjust in line with interest rates.

With the Middle East crisis pushing up commodity prices, the European Central Bank has projected inflation could spike to 3.1% in Q2 2026, bringing back heightened interest rate volatility once more.

Vanilla corporate bonds, which are mostly fixed rate, are more sensitive to changing rate expectations as they typically carry around 4-6 years of duration risk. As floating rate instruments, European ABS and CLOs carry virtually zero duration, so they are less exposed to the guessing game around how central banks will respond to the Middle East conflict.

In addition to lower rates-driven volatility, ABS and CLO bondholders can expect to benefit from any rate hikes as their floating rate coupons would rise in line with policy rates.

ABS asset pools are better insulated from geopolitical shocks

Geopolitical shocks such as tariff announcements, supply chain disruption and energy price surges directly impact corporate margins, credit quality and ratings, and tend to be quickly priced into corporate bonds.

The pools of assets that back European ABS transactions – mortgages, auto loans, consumer loans – are remote from direct corporate risks through ringfencing in a special purpose vehicle, with contractual loan repayments on underlying consumer loans going directly to pay the coupons on the bonds.

Diverse pools of loans to prime consumers in Europe have a long, demonstrable track record of stable credit performance (see Exhibit 1). This can provide insulation from geopolitical and macroeconomic events, and helps to explain why spreads in ABS have historically shown low correlation with pure corporate credit markets through periods of broader market volatility.

ABS spread premium is a volatility buffer

Partly due to the specialist nature of the asset class, ABS and CLO spreads fundamentally tend to offer higher spreads than corporate bonds of a similar credit rating (see Exhibit 2).

Coming into the shock of the Iran conflict, corporate bond spreads had compressed to levels that left very little cushion for bad news. Having recovered relatively quickly on news of the ceasefire, corporate bond spreads remain historically tight, with spreads in some sectors now tighter than their pre-conflict levels.

In our view, the spread premium available in ABS and CLOs represents a more attractive entry point for fixed income investors, with the additional (floating rate) income also offering more protection against further bouts of volatility.

Going forward, market conditions continue to favour ABS and CLOs

With uncertainty surrounding the timeline of any resolution to the conflict, energy prices are set to remain higher for longer, presenting a meaningful risk to GDP growth, inflation and supply chains. 

This is the type of scenario in which we would expect low duration, structurally protected assets to outperform more mainstream areas of corporate credit, which are more exposed to corporate earnings and monetary policy expectations.

European ABS markets are also enjoying a regulatory headwind thanks to proposed regulatory reforms, which from the beginning of 2027 will cut capital charges on AAA ABS materially and likely lead to structurally higher insurance and bank demand.

With more buyers in the market, yields may compress, providing a potentially attractive timing opportunity.