Overview

Asset-backed finance (ABF) is a form of private credit that is backed by self-amortizing pools of contractual assets (for example, loans, leases and mortgages), in contrast to traditional corporate private credit in which repayment relies on the individual company’s fundamentals and ability to refinance. Financing the breadth of the global economy–everything from transportation to consumer finance–through these structures has been a cornerstone of bank and insurance business. 

We believe ABF will become an increasingly important private asset class in the coming years as banks pare back their activity in the area, giving rise to a significant opportunity for alternative lenders. We think it’s the early moments of a new chapter in the evolving private credit story, with private lenders estimated to currently provide less than 5% of asset-backed financing within the $5.5 trillion universe. Much of the private capital growth in the last decade has tilted towards direct lending.¹

Poised for Growth 

We believe ABF is on the verge of significant growth for alternative lenders as a result of banks continuing to reduce their footprint in response to various headwinds in a wide range of lending activities. Fiscal tightening, questions around the reliability of deposits and the value of assets on their balance sheet and compounding regulatory pressures have resulted in a general conservatism and risk repositioning by banks. The continued decline of banks willing to participate as the primary providers of asset-backed financing is creating an opening for private ABF lenders to fill the void.

At the same time, demand for non-bank lending is increasing and there is a tremendous amount of opportunity, given the ABF funding gap. Mutual funds and hedge funds prefer assets with greater liquidity, insurers favor instruments with term funding and are often limited to investments that may be “rated,” and private equity typically pursues investments with higher risk/return profiles. This underscores the significant opportunity ABF presents for private lenders, particularly experienced ones who can navigate the complexity of ABF borrowers’ financing needs, to earn a “complexity premium” (over available spreads for traditional corporate lending or comparable asset-backed securities) in this currently underserved area. 

ABF has several features that distinguish it from corporate direct lending and may represent attractive investment features. Direct lending depends on a single company’s EBITDA² to support repayment, while ABF relies on a pool—of both income and principal from often multiple borrower cash flows, typically on a diversified portfolio of credit receivable “assets.” As a result ABF is less reliant on a single borrower’s performance and may represent a more broadly diversified portfolio given the breadth of asset sectors served. ABF investments typically also include various structural protections, with assets housed in bankruptcy remote special purpose vehicles. Unlike the sometimes “covenant light” corporate direct lending market, ABF is currently a “covenant heavy” market, with creditor rights helping to further mitigate risk. 

These features of ABF support a broad range of potential benefits, including strong income and attractive risk-adjusted returns.

The Bottom Line 

We believe that ABF should be viewed as a complement to direct lending in a portfolio’s private credit allocation. Diversifying across private credit strategies, by combining both direct lending and ABF strategies, may be crucial for optimal portfolio construction and can help strengthen portfolios by offering compelling income streams, attractive risk-adjusted returns, and important diversification benefits. Still, while ABF is emerging as a significant, long-term opportunity, it is not a homogenous, easily accessible asset class. We believe that working with an experienced manager is essential to navigate the complexity of the asset class. Those managers who can cast a wide net for attractive opportunities and keep risk control at the forefront without sacrificing on achieving strong returns stand to capitalize on what we believe is the next frontier of private credit.

ENDNOTE 

1 Source: Preqin Special Report: The Future of Alternatives in 2027 (published October 2022); Preqin Global Report, Private Debt 2024 (published December 2023). There is no assurance that such events or projections will occur, and actual outcomes may be significantly different than those shown. 

2 EBITDA: Earnings Before Interest, Tax, Depreciation and Amortization. 7 Source: Internal Brookfield Research. There is no assurance that such events or projections will occur, and actual outcomes may be significantly different than those shown here. 

A WORD ABOUT RISK 

As an asset class, private credit is comprised of a large variety of different debt instruments. While each has its own risk and return profile, private credit assets generally have increased risk of default, due to their typical opportunistic focus on companies with limited funding options, in comparison to their public equivalents. Because private credit usually involves lending to below investment grade or non-rated issuers, yield on private credit assets is increased in return for taking on increased risk. Investments in real estate-related instruments may be affected by economic, legal or environmental factors that affect property values, rents or occupancies of real estate. Infrastructure companies may be subject to a variety of factors that may adversely affect their business, including high interest costs, high leverage, regulation costs, economic slowdown, surplus capacity, increased competition, lack of fuel availability and energy conservation policies. Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. High-yield bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally, the longer a bond’s maturity, the more sensitive it is to this risk. Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. The information in this publication is not and is not intended as investment advice, an indication of trading intent or holdings, or prediction of investment performance. Diversification does not guarantee a profit or protect against loss. Views and information expressed herein are subject to change at any time. Brookfield disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources; however, Brookfield does not warrant its completeness or accuracy. Opinions expressed herein are current opinions of Brookfield, including its subsidiaries and affiliates, and are subject to change without notice. Brookfield, including its subsidiaries and affiliates, assumes no responsibility to update such information or to notify clients of any changes. Any outlooks, forecasts or portfolio weightings presented herein are as of the date appearing on this material only and are also subject to change without notice. Past performance is not indicative of future performance, and the value of investments and the income derived from those investments can fluctuate. 

FORWARD-LOOKING STATEMENTS 

Information herein contains, includes or is based on forward-looking statements within the meaning of the federal securities laws, specifically Section 21E of the Securities Exchange Act of 1934, as amended, and Canadian securities laws. Forward-looking statements include all statements, other than statements of historical fact, that address future activities, events or developments, including, without limitation, business or investment strategy or measures to implement strategy, competitive strengths, goals, expansion and growth of our business, plans, prospects and references to our future success. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe” and other similar words are intended to identify these forward-looking statements. Forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining our actual future results or outcomes. Consequently, no forward-looking statement can be guaranteed. Our actual results or outcomes may vary materially. Given these uncertainties, you should not place undue reliance on these forward-looking statements. It is not intended to provide an overview of the terms applicable to any products sponsored by Brookfield Corporation and its affiliates (together, “Brookfield”). Information and views are subject to change without notice. Some of the information provided herein has been prepared based on Brookfield’s internal research, and certain information is based on various assumptions made by Brookfield, any of which may prove to be incorrect. Brookfield may not have verified (and disclaims any obligation to verify) the accuracy or completeness of any information included herein, including information that has been provided by third parties, and you cannot rely on Brookfield as having verified any of the information. The information provided herein reflects Brookfield’s perspectives and beliefs as of the date of this commentary.

INDEX PROVIDER DISCLAIMER 

The quoted indexes within this publication are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. There may be material factors relevant to any such comparison, such as differences in volatility and also regulatory and legal restrictions between the indexes shown and any investment in a Brookfield strategy, composite or fund. Brookfield obtained all index data from third-party index sponsors and believes the data to be accurate; however, Brookfield makes no representation regarding its accuracy. Indexes are unmanaged and cannot be purchased directly by investors. 

Brookfield does not own or participate in the construction or day-to-day management of the indexes referenced in this document. The index information provided is for your information only and does not imply or predict that a Brookfield product will achieve similar results. This information is subject to change without notice. The indexes referenced in this document do not reflect any fees, expenses, sales charges or taxes. It is not possible to invest directly in an index. The index sponsors permit use of their indexes and related data on an “as is” basis, make no warranties regarding the same, do not guarantee the suitability, quality, accuracy, timeliness and/or completeness of their index or any data included in, related to or derived therefrom, and assume no liability in connection with the use of the foregoing. The index sponsors have no liability for any direct, indirect, special, incidental, punitive, consequential or other damages (including loss of profits). The index sponsors do not sponsor, endorse or recommend Brookfield or any of its products or services. Unless otherwise noted, all indexes are total-return indexes.

INDEX DEFINITIONS 

The Preqin Infrastructure Index captures in an index the return earned by investors on average in their private infrastructure portfolios, based on the actual amount of money invested in private capital partnerships. Each data point is individually calculated from the pool of closed-end funds for which comprehensive performance data is held, as of both the start and end of the quarter. 

The Preqin Real Estate Index captures in an index the return earned by investors on average in their private real estate portfolios, based on the actual amount of money invested in private capital partnerships. Each data point is individually calculated from the pool of closed-end funds for which comprehensive performance data is held, as of both the start and end of the quarter. 

The Preqin Private Equity Index captures in an index the return earned by investors on average in their private equity portfolios, based on the actual amount of money invested in private capital partnerships. Each data point is individually calculated from the pool of closed-end funds for which comprehensive performance data is held, as of both the start and end of the quarter. 

The Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross of fee performance of U.S. middle market corporate loans, as represented by the asset-weighted performance of the underlying assets of Business Development Companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements. 

The FTSE EPRA Nareit Developed Real Estate Index is an unmanaged market capitalization-weighted total-return index that consists of publicly traded equity REITs and listed property companies from developed markets. 

The FTSE Global Core Infrastructure 50/50 Index gives participants an industry-defined interpretation of infrastructure and adjusts the exposure to certain infrastructure subsectors. The constituent weights are adjusted as part of the semi-annual review according to three broad industry sectors: 50% Utilities; 30% Transportation, including capping of 7.5% for railroads/railways; and a 20% mix of other sectors including pipelines, satellites and telecommunication towers. Company weights within each group are adjusted in proportion to their investable market capitalization. 

The ICE BofA U.S. High Yield Index tracks the performance of U.S.-dollar-denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market.

The ICE BofA Merrill Lynch Global High Yield European Issuers Non-Financial 3% Constrained Ex Russia Index is a sub-index that contains all securities in the broader index except those from financial issuers or with Russia as their country of risk but caps issuer exposure at 3%. The index is rebalanced monthly. The index is USD hedged. 

The MSCI World Index is a free-float-adjusted market-capitalization-weighted index that is designed to measure the equity market performance of developed markets. 

The S&P 500 Index is a market-cap weighted equity index of 500 widely held, large-capitalization U.S. companies. 

The Morningstar LSTA US Leveraged Loan Index is a market-value weighted index designed to measure the performance of the US leveraged loan market. 

The Nasdaq Index is a market-cap weighted index tracking companies traded on the Nasdaq stock market.

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