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Beyond traditional fixed income: Diversifying into specialty finance

Structural drivers are propelling specialty finance into sharp focus. Traditional bank lenders have narrowed their lending activities and speciality finance has grasped the opportunity. Explore how this investment area could be an alternative income source.

Within the rapidly growing universe of structured finance, specialty finance has emerged as one of the most attractive opportunities, in our view. Driven by long-running structural drivers, specialty finance in Europe has benefited from banks’ increased focus on balance sheet efficiency and capital optimisation amid regulatory changes following the global financial crisis (Basel III Endgame) and years of dragging profitability. Non-bank, specialist lenders’ need for private asset-backed financing solutions has created opportunities as banks narrow their lending while further support for the asset class has come from investors seeking both greater portfolio diversification and alternative sources of higher returns and income generation.
 
Investors have increasingly looked beyond traditional fixed income and credit asset classes and allocated capital to private and structured credit. However, traditional forms of private corporate credit including broadly syndicated loans (BSL) and mid-market direct lending have been the de-facto destination, accounting for slightly over half of all private credit allocations, according to a Preqin 2024 report. As these markets mature, perhaps now is the time to ask whether investors should seek to further diversify their allocations? We believe specialty finance is an area that investors should consider diversifying into as they develop their allocations to private credit over the coming years.
 
What is the specialty finance opportunity?
Specialty finance or ‘asset-backed’ private credit (asset-backed finance) involves granular pools of assets, typically consumer and small-cap corporate/commercial loans and leases, credit and receivables financing, originated by banks and non-bank, ‘specialty’, lenders.
 
First, it is worth reiterating what the specialty finance asset universe comprises of as the range of assets that are generally considered part of the addressable opportunity set can be broad and varied – from well-established areas like consumer and mortgage finance to small business loans (working capital and other contractual cashflows), as well as transactions backed by ‘hard’ physical assets (equipment leasing, aviation) and esoteric asset classes.

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