Private credit has experienced significant growth over the last ten years. The appeal was straightforward: during periods when policy rates hovered near zero, investors looked for financial system. We do not share this view. In our assessment, recent headlines have conflated isolated areas of weakness with a broader decline in private credit fundamentals.
This is not a market that allows for complacency, however. Performance dispersion is increasing among private credit fund managers. AI-driven disruption is impacting software-heavy portfolios, and yields are beginning to normalize.
It is an ideal time to reassess the outlook for private credit—identifying potential pitfalls to avoid and opportunities to pursue. Manager selection is more important than ever. Our full analysis of the private credit market is available here.
In this report, we focus on an opportunity we find compelling: a segment of private credit known as asset-backed finance (ABF).
The power of diversification within private credit
What is asset-backed finance? These are loans secured by underlying assets such as auto loans, equipment leases, and residential mortgages. As a long-established form of credit, ABF is receiving renewed attention, and for good reason. We believe now is an opportune time to consider incorporating asset-backed finance into a diversified private credit portfolio.
To be clear: Asset-backed finance serves as a complement to, not a substitute for, direct corporate lending. Depending on the risk profile and capital structure, strategies in this space have the potential to generate returns in the high single digits—roughly a 200-250 basis point premium over comparable public securitized products—with some segments targeting even higher levels. ABF may also offer a way to diversify credit risk away from pure corporate exposure, which is particularly useful as corporate direct lending returns normalize. The structural tailwinds supporting ABF, such as bank retrenchment and regulatory pressure on traditional lenders, appear likely to continue. Finally, as a durable allocation within private credit, ABF can potentially improve portfolio resilience across various credit cycles.
Asset-backed finance 101
Asset-backed finance is essentially private lending backed by tangible collateral and diversified pools of contractual cash flows. The underlying assets typically produce predictable payment streams that service the debt, independent of the financial performance of any single corporate borrower.
While that may sound complex, the key takeaway is that ABF provides multiple layers of diversification. The underlying collateral pools are composed of many individual cash flow streams supported by a wide variety of distinct assets. Consider the broad range of ABF collateral listed below.
