Asset-based finance the next big thing in private credit, KKR’s Daniel Pietrzak says

Asset-based finance is poised to be the next “big growth” area in the private credit market, said Daniel Pietrzak, partner and global head of private credit at KKR.

“I think we’re in the earlier innings for the asset-based finance market,” Pietrzak told Pensions & Investments in an interview. “I equate the asset-based market a lot to probably where the direct lending market was, let’s call it seven years ago. Not a lot of scaled capital has been raised. I think investors are still thinking about where they put it in their asset allocation model.”

Asset-based finance is a wide-ranging segment of private credit.

It encompasses consumer and mortgage finance, including auto loans; loans and financing on hard assets such as aircraft leasing and home rentals; commercial finance, including lending to small and medium-sized businesses, equipment leases and receivables financing as well as contractual cash flows that include music and healthcare royalties and intellectual property.

With the wide range of strategies, return expectations vary, from high single digits to low teens net returns.

Growth in private asset-based finance gained traction following the global financial crisis in 2008. However, there is no consensus definition on the exact size and make-up of the asset-based finance universe.

KKR defines asset-based finance as financing or acquiring portfolios backed by financial or hard assets. And Pietrzak said KKR approximates the asset-based market at $6.1 trillion. KKR estimates that it will hit $9.2 trillion by 2029.

Credit overall overtook private equity as KKR’s largest business in early 2021. Today, the firm manages about $243 billion in credit. KKR launched its asset-based finance business in 2016 and has seen rapid growth. It’s ABF platform managed more than $66 billion in assets as of Sept. 30, up 40% from the prior year, according to the firm’s third-quarter earnings call.

That’s up from approximately $35 billion in July 2022 when there were 35 dedicated asset-based employees. Today there are over 50. Pietrzak points to adding lawyers to structure deals, growing portfolio monitoring units and the workout team. He expects more growth to come in analytics.

“We’ve got such a big asset-based footprint; we have a lot of data in-house, and across asset classes, across geographies. That is a competitive advantage for us, right? But we need to make sure we’re mining that appropriately,” he said.

Institutional investors, including pension funds, are making allocations to asset-based finance, although there is no standard for where asset-backed finance is placed in a portfolio or even labeled within private credit allocations.

That said, KKR has seen institutional allocations to its funds in the asset-based segment.

The South Carolina Retirement System Investment Commission, Columbia, made a commitment of up $100 million to KKR Asset-Based Finance Partners II, according to P&I data reported in March. The fund makes privately originated credit investments backed by large and diversified pools of financial and hard assets.

KKR closed its first dedicated fund to asset-based opportunities, KKR Asset-Based Finance Partners I in July 2022 at $2.1 billion. It also has a high-grade ABF strategy.

Over the past year, some recent KKR deal examples in the space have included providing, with other investors, approximately $500 million in debt financing to HarbourView Equity Partners for music investments; providing a $300 million corporate credit facility to Orgis Energy for the construction of solar and storage projects; and along with Carlyle Group, purchasing an approximately $10.1 billion portfolio of prime student loans from Discover Financial Services.

And there’s likely more growth to come, with 69% of credit providers, banks, private equity shops, advisory firms and other respondents pointing to more dealmaking activity ahead in asset-based lending and investment grade areas of private credit, according to PitchBook LCD's fourth quarter 2024 global private credit survey of more than 80 respondents.

Other pension funds and institutional investors have been making sizeable allocations to asset-based finance in recent months.

In March, the $27.2 billion Louisiana Teachers' Retirement System approved a commitment of up to $125 million to Castlelake’s Asset-Based Private Credit III. In June, the New Mexico State Investment Council, Santa Fe, which manages the $58 billion sovereign wealth fund, committed up to $200 million to AB CarVal Asset-Based Fund, an evergreen asset-backed fund managed by AB CarVal Investors. And in September, the $45.2 billion Indiana Public Retirement System, Indianapolis, committed $200 million to Atalaya Special Opportunities Fund IX managed by Atalaya Capital Management.

Insurers also are allocating to asset-based finance, with 44% percent saying they plan to increase long-term allocations to the segment, the highest of any private credit area, according to a June Moody’s survey and analysis of 30 of the world’s largest insurers.

The average asset-based finance investment for U.S. and Canada insurers is 3% with 7.3% representing the highest allocation, according to Moody’s.

There has been a pick-up of interest in asset-based finance especially since direct lending spreads have come in a bit, said Karin Anderson, director, credit manager research at WTW.

A diversifier

And investors see asset-backed lending as a diversifier with different collateral backing that complements existing private credit strategies, she added.

“(Asset-based finance) is probably pretty high on the list for investors that are already invested in direct-lending strategies,” she said. “It’s the diversification of collateral component, valuations are pretty decent compared to other parts of the market, slightly shorter time commitment compared with other illiquid asset classes and you have a pretty nice range of return targets 10% to 15% net in a lot of cases. So, it’s very reasonable to assume this will be a popular area.”

And while the market has been around for decades, Anderson pointed to similarities with the growth in the public ABS market, which now comprises a sprawling menu of deal types.

Many investors keep asset-based finance in its own asset allocation bucket because it can contain a wide variety of loan types, from small business loans and equipment financing to the more esoteric area of drug and music royalties, she said.

The asset-based segment has been the focus of merger and acquisition activity in the broader marketplace this past year with Blue Owl acquiring Atalaya Capital Management, a firm primarily focused on asset-based credit investments across consumer and commercial finance, corporate and real estate assets, for $450 million.

Pietrzak expects to see corporate pension and public pension plans grow their private credit allocations in coming years beyond direct lending.

“I think there's been a… concept out there that people have been wanting to increase their private credit allocations, but they've been wanting to do that in a diversified manner,” he said, adding, “I think probably the biggest benefactor of that will be that asset-based finance bucket.”