Why we believe asset-based lending is attractive now

Executive summary:

• We believe reduced competition and favorable terms make asset-based lending a compelling alternative to crowded corporate cashflow lending markets.
• Asset-based loans are secured by specific assets, allowing lenders to recover funds by selling collateral, even if the borrower defaults.
• With shorter loan durations (1-2 years), asset-based lending offers faster capital returns and greater flexibility than corporate loans.
• Diversifying with asset-based loans enhances stability and adapts to changing market conditions, balancing risk and return.

Private credit is an asset class that is increasingly capturing investor attention as an alternative to public markets. However, while it is $1.5 trillion in size and is estimated to grow to $2.8 trillion by 2028,¹ much of this investment has been directed toward corporate cashflow lending - an area now facing mounting competition, tighter spreads, and looser terms.

In this environment, asset-based lending can complement existing cashflow lending exposure, offering not only attractive risk-return, but also enhanced downside protection.

What is asset-based lending?

Asset-based loans are secured by specific assets. These assets can range from tangible ones like real estate and equipment, to intangible assets, such as intellectual property, brand rights, and accounts receivable. Importantly, it differs from corporate loans because an asset-based loan is primarily concerned with the liquidation value of the collateral, while a corporate loan relies on the borrower's overall financial health and operational success.

In practice, this difference shifts the asset-based lender's focus. Whether a borrower's business thrives or struggles becomes less critical as long as the collateral retains its value. For instance, a loan backed by a fleet of delivery trucks could still be repaid by selling the trucks, even if the logistics company struggles. This structure can make asset-based lending more resilient in economic downturns.

The breadth of collateral types used in asset-based lending also allows for a wide variety of risk-return profiles. For example, holding a single-family home as collateral versus bitcoin both present very different potential volatilities in value. Moreover, the seniority of a loan can impact the likelihood of its repayment, adding greater downside protection if desired.

Why invest now?

As an asset class, one of private credit's appealing features is its relatively quick return of capital, especially compared to longer-term investments like private equity or real estate. Asset-based loans often enhance this liquidity, with many loans featuring weighted-average lives of just 1-2 years, compared to 3-4 years for typical corporate loans.

This shorter duration offers investors greater flexibility—whether to rebalance portfolios, reinvest in new opportunities, or adapt to market changes. For investors frustrated with the "denominator effect"—where a sharp decline in one part of a portfolio reduces its overall value and distorts allocation targets in volatile markets—this added liquidity can be a welcome feature.

With elevated pricing on risk assets many investors are questioning how to protect their portfolios. Asset-based lending can serve as a buffer against losses experienced during market downturns. For instance, even if a borrower defaults, the lender can often recover the full value of the loan—plus additional fees in many instances—by selling the collateral. Conversely, for cashflow loans, if the company falters, the loan is at greater risk of non-repayment, and a forced sale of the company during a cyclical downturn in its profitability.

Attractive risk-return

Asset-based lending offers compelling returns relative to corporate cashflow lending:

• Bank retrenchment: U.S. regional banks have long played a significant role in asset-based lending, but regulatory changes in the aftermath of the financial crisis, as well as the 2023 Silicon Valley Bank collapse and subsequent deposit flight, have led many to reduce or exit the space. This has left a gap for private lenders to fill, often on favourable terms.
• Crowded marketplace: As private credit has boomed, most of the new capital has flowed into corporate direct lending, making the segment more competitive and commoditised. This is particularly true in the U.S. rather than Europe due to the rapid uptake on vehicles designed for individual rather than institutional investors. The funds in this space can't or would struggle to pivot materially into asset-based lending, and have to remain in corporate direct lending, but with less compelling terms. Meanwhile, asset-based lending has grown more modestly, preserving its attractive risk-adjusted returns for investors.

The bottom line

So, when clients ask why private credit, we believe there are some very compelling reasons why now, more than ever, investors should be considering an allocation to private credit. Today's environment is especially enticing for specialist investment strategies where there is less competition that can take advantage of wider spreads to lock in higher yields. In our opinion, that should lead to better returns and more income for investors now and into the future.

¹ Morgan Stanley, Understanding Private Credit

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.

Private Credit is considered a high-risk investment. Investing in a private credit involves considerable risks, you should make sure you understand the risks before investing.