Asset-based finance is emerging as an attractive source of returns and diversification for investors looking for new access points to the private credit asset class.
Based on consumer and corporate loans backed by income-generating hard assets, asset-based finance is a burgeoning market yet to be fully tapped. “There’s more than $6.3trn in debt in the specialty finance ecosystem and more than twice that in the under-pressure banking system,” said Brian Resnick, director and senior investment strategist – alternatives, at AllianceBernstein (AB).
By comparison, this dwarfs the combined $3trn in the direct lending and liquid high-yield markets.
A new chapter in private credit
The scale of the opportunity follows from asset-based finance providing much of the funding for the real economy, across both the consumer and corporate sectors. The loans are on assets ranging from energy infrastructure and leased airplanes, to pools of financial assets such as auto loans and residential mortgages.
“These assets secure the loan and generate their own cash flows,” explained Resnick. “In a default, that asset backing generally provides strong and more predictable recoveries.”
Further, with such diverse economic drivers of the underlying assets, asset-based loans are highly diversified. For example, pools of consumer loans originated by specialty finance companies often include thousands, possibly tens of thousands, in each deal.
Compared with corporate loans, which pay some income but only repay principal at the end of the term, asset-based loans are self-amortising – they repay their principal gradually over time, in turn becoming less risky.
As a result, within the overall private credit mix, Resnick describes asset-based finance as a complementary category to corporate lending.
Maximising the potential
Despite the size of the specialty finance ecosystem, this opportunity hasn’t yet been fully reflected in investors’ allocations.
According to Resnick, this is probably because it’s a wide-ranging asset class and not all private lenders have the know-how to navigate it effectively, such as how to assess individual loans and gauge the balance between opportunity and risk.
However, if private lenders get the formula right, there are notable benefits for investors.
Among them is the yield premium on offer. “[This is] because they’re less liquid than similar public securities – and because lending arrangements can be complex,” said Resnick.
Along with healthy income, they also offer potential capital gains, because they’re often made at a discount.
And within a portfolio, asset-based finance can complement investments in direct corporate lending and public-market risk assets such as corporate bonds and equities.
“We believe they bring a level of economic diversification that may help cushion portfolios in declining and turbulent markets,” added Resnick.
