PIMCO: From direct lending to asset-based finance

September 16, 2026

With capital increasingly crowding into traditional direct lending, Lotfi Karoui, Multi-asset Credit Strategist at PIMCO, argues that attractive opportunities lie in asset-based finance and other collateralbacked strategies. He highlights the importance of cash-flow resilience, valuation discipline and adequate compensation for illiquidity.

By our editorial team

 
Corporate direct lending is often described as an increasingly crowded market. Where do you currently see the most attractive relative value, and which parts of the market do you deliberately avoid?

‘Investors should distinguish between private credit and direct lending. Direct lending has been the primary growth engine of private credit over the past decade, but it is only one part of a much broader opportunity set. As the segment has grown rapidly, capital has increasingly outpaced opportunity, leading to weaker underwriting standards, greater portfolio overlap and, in some cases, insufficient compensation for illiquidity.

Today, we see more attractive relative value in areas where potential returns are driven by collateral and contractual cash flows rather than corporate earnings growth. Asset-based finance (ABF), selected consumer and mortgage credit, and parts of private real estate debt stand out.

By contrast, we are more cautious toward crowded sponsor-backed direct lending, particularly where software exposure is elevated, documentation has weakened or valuations rely heavily on model-implied or discretionary marks. A growing concentration in software and uncertainty around the long-term impact of AI-driven disruption have introduced risks that are not always reflected in current book valuations.’

Asset-based finance is frequently presented as a more diversified alternative to sponsor-backed direct lending. Which underlying asset types or lending niches look most compelling today, and what makes their return drivers genuinely different?

‘The most compelling opportunities are those supported by large, diversified pools of cash-flowing collateral. These include residential mortgage credit, selected consumer lending, commercial real estate lending, hard assets and other specialty finance opportunities.

What distinguishes these opportunities from traditional direct lending is that their potential return drivers are fundamentally different. Direct lending is primarily corporate credit risk, with outcomes heavily influenced by earnings growth, leverage and sponsor behaviour. In contrast, ABF returns are often linked to contractual cash flows, collateral performance, asset servicing and structural safeguards embedded within the transactions.

This distinction becomes particularly valuable later in the credit cycle. While corporate credit performance is often closely tied to the health of the economy and the earnings cycle, many ABF sectors benefit from diversified collateral pools and downside risk mitigants that can help reduce sensitivity to broader corporate stress. For long-term investors, that can provide both diversification and potential for more resilient risk-adjusted returns.’

How should investors distinguish genuinely resilient collateral-backed lending from structures that only appear defensive because of financial engineering, ratings or headline asset coverage?

‘Investors should start with cash flows rather than labels. The key question is whether the underlying assets can continue generating cash flows through periods of economic stress, and whether lenders have enforceable rights if conditions deteriorate.

We would focus on several factors. Is the collateral granular and diversified? Are the cash flows contractual and supported by a proven servicing framework? How robust are the structural safeguards? And how are the assets valued?
 

Investors should start with cash flows rather than labels

 
Recent debates around private credit valuations highlight an important distinction: valuation frequency is not the same as price discovery. Producing daily marks using models does not automatically improve transparency if valuations are not anchored to observable market transactions. In our view, governance, methodology and consistency of valuation matter far more than simply increasing the frequency of pricing updates.

Investors should therefore be cautious of structures that appear defensive because of ratings, financial engineering or headline asset coverage, but where the quality of collateral, cash-flow resilience and valuation discipline are less robust than they first appear.’

What role should alternative credit play in a Dutch pension fund’s strategic allocation: as a substitute for traditional direct lending, as a diversifier within private credit, or as a broader complement to public fixed income?

‘We believe alternative credit is best viewed as both a diversifier within private credit and a complement to traditional public fixed income, rather than simply a substitute for direct lending.

For pension funds, the starting point should be the role the allocation is expected to play within the broader portfolio. Some exposures may be designed to enhance income potential, others may improve diversification, access unique collateral pools or provide greater downside risk mitigation.

ABF is particularly interesting in this context. It offers access to a broad range of privatemarket opportunities whose potential return drivers differ from those of corporate credit. In some cases, these exposures can exhibit investment-grade-like characteristics while still providing a liquidity premium and access to opportunities that are difficult to source in public markets.

The key consideration remains liquidity. Public fixed income currently offers transparent price discovery, deep liquidity and attractive starting yields. Investors should therefore require clear compensation before accepting more limited liquidity in private market structures. It’s not just a question of whether an investment is private or public, but whether investors are being adequately compensated for the risks they assume.’

With valuations, liquidity terms and underwriting discipline receiving more scrutiny across private credit, what are the three most important questions investors should ask a manager before committing capital to an alternative credit strategy?

‘First: Are we being sufficiently compensated for illiquidity? As the gap between public and private market spreads narrows, investors need to determine whether the additional return potential available in private markets still justifies the loss of liquidity and transparency.

Second: What is actually driving the return? Investors should understand whether returns are being generated by collateral quality, structural safeguards and origination expertise, or whether they depend largely on leverage, optimistic valuation assumptions or continued access to benign financing conditions.

Third: How robust are valuations and liquidity management under stress? Private credit does not benefit from continuous market price discovery. Investors should therefore understand who determines the marks, how independent the process is, how much valuation dispersion exists across comparable assets, and how the manager would manage liquidity during periods of market stress or elevated redemption activity.

The strongest managers should be able to explain not only how they source potential opportunities, but also how their portfolios are designed to withstand periods of valuation uncertainty and scarce liquidity.’