What might be a downside of investing in asset-backed securities?

Investing in asset-backed securities (ABS) indeed carries a downside related to default risk. Asset-backed securities are typically created by pooling various types of assets, such as mortgages, auto loans, or other receivables, and then issuing securities backed by these assets. One of the primary risks associated with ABS is that the underlying borrowers may default on their payments. This can lead to a decline in the cash flow available to meet the scheduled payments to ABS investors, thereby affecting their returns.

This risk is particularly significant in volatile economic conditions or in sectors experiencing high levels of delinquency, such as subprime mortgages. If a notable number of the underlying asset borrowers fail to fulfill their obligations, the value of the ABS may drop, and investors may suffer losses. Understanding the default risk is essential for assessing the overall risk profile and potential return associated with asset-backed securities.