Asset-backed investing has been suffering from bad publicity, writes David Conlon, manager of the GCP Asset Backed Income fund.
The likes of collateralised loan obligations and mortgage-backed securities - the infamous products immortalised in The Big Short - were roundly condemned as one of the root causes of the global financial crisis.
Over 10 years later, the world is still feeling the effects of the crisis with interest rates at near-record lows and sluggish growth lingering in some quarters.
However, out of crisis, the asset-backed loan sector has been steadily transforming and adapting.
While once a space dominated by the mainstream 'big banks', which had the resources and capability to fund a whole swathe of projects in need of investment, the sector has had to adapt to become something far more nuanced.
This adaptation has resulted in a large number of new and different players in the market seeking to fill the resulting void. There are now multiple lenders vying for business, from challenger banks to alternative and specialist lenders.
Even the likes of pension funds have caught on to the opportunity to harness the returns and security offered by asset-backed lending and diversify their holdings.
Bridging the gap
The market has had to evolve since the Global Financial Crisis, driven in a large part by regulatory pressure, structural changes in credit markets and the ongoing hunt for yield by investors in a low-rate environment.
With regulators clamping down on the big banks' allocation models, the availability of mainstream lending from traditional institutions has been severely restricted since 2007.
This reduction in available funding from traditional sources has played perhaps the biggest role in expanding the universe of opportunity on offer to the new batch of alternative lenders.
Traditional lenders prefer to stick to simpler, shorter-term high value loans in order to cover their higher cost base and regulatory burdens, with one challenger bank's recent issues proving a pertinent example of what happens when the banks get their risk allocation models wrong.
The alternative lenders have stepped up to meet the demand for the loans that have become increasingly difficult for mainstream lenders to fit within their restricted business models.
This has created a whole area of opportunity for lenders, unburdened by the regulatory pressures of the banks, who are willing and able to adapt to the needs of the market.
The market is being spurred on by investors seeking out the reliable and attractive yields on offer.
Specialist lenders can be better placed to provide smaller loans for more flexible time periods, while having the ability to commit the resource and innovation required to identifying an appropriate funding solution for a specific borrower or asset.
This tailored service for borrowers, structured to the needs of the borrowers, can often allow the specialist lender to secure an attractive yield.