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The global private credit market is set to grow to $2.8 trillion by 2028, according to Morgan Stanley.1 Spurring this growth are the prospects of high returns, low loss rates, and portfolio diversification benefits. As the market expands, so do the strategies available to investors seeking to capitalize on these opportunities.
Historically, direct lending has been the dominant private credit strategy. However, asset-backed finance is rapidly gaining traction, especially during periods of market dislocation and economic uncertainty. For example, in 2024, Pimco raised $2 billion for a new asset-backed finance strategy, a crucial component of the bond giant’s expansion into private lending.2 Other major players, such as the Louisiana Teachers’ Retirement System, the New Mexico State Investment Council, and the Indiana Public Retirement System, have also supported asset-based finance with commitments totaling hundreds of millions of dollars to related funds.3
As these two strategies evolve, financial advisors must understand their nuances to align client portfolios with current market conditions and future financial goals.
Direct lending: The historically popular strategy
Direct lending involves nonbank creditors providing loans directly to businesses without intermediaries. As the largest category of private credit, it comprises 44% of assets under management, according to BlackRock.4
It is the largest for good reason, as there are numerous benefits to direct lending. It can offer attractive returns with less downside risk and volatility compared to more liquid credit strategies of broadly syndicated loans. Additionally, lenders have superior risk control, as they have better access to management than investors in more liquid strategies. Borrowers, on the other hand, benefit from simplicity, quicker execution, and flexibility in loan structuring.
However, direct lending is not without its challenges. Investors face limited liquidity, and the strategy’s success depends on the skills of the manager to navigate the space. Effective managers must maintain robust sourcing pipeline, conduct thorough due diligence, and possess detailed knowledge of structuring investments. Without these competencies, the risks can outweigh the benefits.
Asset-based lending: A growing force in private credit
Asset-backed finance involves lending against a company’s assets, such as inventory, accounts receivable, or equipment, which serve as collateral. Asset-backed lending (ABL) has emerged as a dynamic and expanding segment within the private credit landscape, often used by small- and medium- size businesses.
KKR, a global private equity and investment company, approximates that the asset-based market is $6.1 trillion and will hit $9.2 trillion by 2029. Pitchbook CDL’s fourth-quarter 2024 global private credit survey found that 69% of respondents pointed to more deal-making activity ahead in the ABL and investment-grade areas of private credit.5
The collateral-based structure of ABL mitigates risks for lenders, making it particularly attractive during periods of economic uncertainty or tighter credit conditions. Moreover, its flexibility allows borrowers to unlock value from assets that may not be available through traditional means. ABL is increasingly being used with high-value assets in growing industries – such as real estate, cryptocurrency, and transportation – to enhance liquidity for investors and businesses alike.
Despite its advantages, ABL too comes with drawbacks. Borrowers potentially face higher interest rates, and lenders bear high monitoring costs. Additionally, the risk of asset seizure in the event of nonrepayment is a critical consideration for borrowers.
Recommendations for advisors
While ABL is gaining momentum and capturing an increasing share of investor interest, financial advisors must weigh each client’s unique goals, risk tolerance, and portfolio needs before determining the best strategy for their clients.
In addition to client needs, to ensure optimal outcomes, advisors should stay informed about regulatory and market developments in the private credit space. A thorough understanding of emerging trends and market dynamics will enable them to identify opportunities and safeguard their clients’ portfolios against potential risks.
Conclusion
The private credit market is undergoing a significant transformation, offering investors and borrowers diverse opportunities through strategies like direct lending and asset-based lending. While direct lending has long been the dominant force in this space, ABL is gaining significant momentum, driven by its risk-mitigating features and expanding applications across high-value sectors like real estate, transportation, and cryptocurrency.
For financial advisors, understanding the intricacies of these strategies is crucial for tailoring portfolios to clients’ needs. Direct lending remains an attractive option for those seeking higher returns and diversification but comes with inherent risks tied to creditworthiness and market conditions. In contrast, asset-backed lending provides a stable alternative, leveraging collateral to mitigate risk and offering flexibility in uncertain economic environments. By staying ahead of market trends and aligning strategies with objectives, advisors can effectively navigate the evolving private credit landscape and unlock its full potential for clients.
Steven Brod is the senior partner, CEO and chief investment officer of Crystal Capital Partners. Crystal is a turnkey alternative investment platform that provides 200+ financial advisory firms exposure to over 50 of the world's leading alternative investment funds.
ENDNOTES
1 Morgan Stanley. Jun. 20, 2024. Understanding Private Credit. https://www.morganstanley.com/ideas/private-credit-outlook-considerations
2 Benitez, Laura and Brush, Silla. Bloomberg. Oct. 30, 2024. Pimco Raises $2 Billion for Asset-Based Private Lending Strategy. https://www.bloomberg.com/news/articles/2024-10-30/pimco-raises-2-billion-for-asset-based-private-lending-strategy
3 Tomkiw, Lydia. Pensions & Investments. Nov. 25, 2024. Asset-based finance the next big thing in private credit, KKR’s Daniel Pietrzak says. https://www.pionline.com/alternatives/kkrs-daniel-pietrzak-thinks-asset-based-finance-next-big-growth-area-private-credit
4 BlackRock. The Growth of Direct Lending – An investor Q&A. https://www.blackrock.com/institutions/en-us/insights/the-growth-of-direct-lending
5 Tomkiw, Lydia. Pensions & Investments. Nov. 25, 2024. Asset-based finance the next big thing in private credit, KKR’s Daniel Pietrzak says. https://www.pionline.com/alternatives/kkrs-daniel-pietrzak-thinks-asset-based-finance-next-big-growth-area-private-credit
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.