By Edwin Wilches, co-head of securitised products at PGIM
Europe is approaching a critical juncture for financial innovation and economic growth. The region has persistently underperformed the US and Australia in GDP growth, underscoring a clear need to mobilise capital more effectively across equity and debt markets.
This structural growth challenge is compounded by Europe’s bank‑centric financing model where nearly 85% of real economy funding is still sourced from banks, which in turn constrains economic expansion by tying growth to bank balance sheet capacity. This dynamic creates a compelling opportunity for securitisation to complement traditional bank lending and help finance the real economy. Particularly in priority areas such as defence spending, the energy transition and infrastructure.
For investors, securitised products have become core portfolio construction tools offering enhanced yield and meaningful diversification relative to traditional corporate credit. Diversified collateral pools support attractive risk‑adjusted returns with lower historical credit migration enabling investors to increase income while strengthening overall portfolio quality.
These attributes position securitised assets as deliberate complements to cash and investment grade credit, or as diversified alternatives to selective high yield exposures. Multi‑sector portfolios, in particular, continue to capitalise on persistent relative value opportunities across securitised markets, such as collateralised loan obligations (CLOs) and commercial real estate tranches.
ABF is growing and increasingly funding AI build-out
While the concept of asset‑based finance (ABF) is not new, the current investment environment is driving renewed demand. Post‑GFC banking constraints, combined with rising capital needs tied to AI‑driven infrastructure and defence spending, have accelerated growth. The global addressable market for ABF is estimated at approximately $10trn, with some forecasts as high as $40trn. Yet deployed capital remains under $1trn, underscoring a significant investment gap and long‑term growth opportunity.
Insurance companies, pension funds and sovereign wealth funds are increasingly allocating to ABF strategies, attracted by compelling illiquidity premia and diversification benefits. Investment grade ABF can offer spreads of 150–200 basis points over similarly rated corporates, while below‑investment grade tranches can generate all‑in spreads in excess of 600 basis points or more. This positions the asset class as a competitive and increasingly utilised complement to corporate direct lending mandates.
Access to opportunities across both public and private markets allows investors to build more resilient portfolios when individual markets experience dislocation, and to capture relative value across cycles without reliance on a single origination channel.
This approach is increasingly relevant in areas such as AI‑related infrastructure, where capital needs span multiple markets, structures and stages of development, favouring platforms with the scale, underwriting discipline and flexibility to deploy capital consistently across conditions.
Exposure to AI disruption
AI‑related volatility within the tech sector is accelerating dispersion across the leveraged loan market in both the US and Europe, creating increasingly selective opportunities for CLO investors. While software exposure is often used as a proxy in CLO analysis, AI‑driven disruption is spreading beyond software into adjacent sectors such as business services and healthcare.
We estimate approximately 11% of US CLO portfolios and 7% of European CLO portfolios have near‑term exposure to AI‑related disruption, with meaningful dispersion across managers.
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Importantly, the impact has been highly tranche‑specific Repricing of risk has been largely concentrated in mezzanine and equity tranches, where dislocation has created opportunities for investors able to underwrite issuer‑level risk and manager quality. Senior tranches have remained largely insulated reflecting structural protections and highlighting the role of tranche selection in portfolio construction.
As markets increasingly distinguish between business models and subsectors, dispersion across CLOs is widening, which favours active management and deep credit underwriting over reliance on just the headline sector exposure.
Loan maturity profiles further shape outcomes. Managers with elevated near‑term software maturities face greater refinancing risk amid tighter credit conditions, while portfolios with longer‑dated maturity schedules benefit from additional runway, reinforcing the importance of manager selection in capturing value through this phase of the cycle.
Inflection point for CLOs
Software exposure in European CLOs is meaningfully lower than in the US. However, the broader sell‑off in software‑related issuers has nonetheless weighed on European mezzanine tranches just as heavily.
While certain managers hold more concentrated software positions relative to the broader European market (average ~7%), software loans in Europe generally benefit from longer‑dated maturity profiles, providing added runway before refinancing pressure emerge. That said, European CLO portfolios tend to be more concentrated than their US counterparts.
As a result, despite lower headline software exposure, idiosyncratic issuer risk is higher, particularly in downside scenarios where weaker recoveries can have an outsized impact, reinforcing the importance of issuer‑level underwriting.
Overall, the repricing of software‑exposed loans marks a clear inflection point for CLO markets across both the US and Europe given uncertainty in outcomes for many of these companies. AI‑related disruption has accentuated differences in portfolio construction, risk management, and manager underwriting discipline.
To date, repricing has been concentrated in equity and mezzanine tranches, while senior tranches have remained well insulated. This environment is increasingly rewarding investors with the ability to underwrite underlying loan portfolios and manager quality at the issuer level, rather than relying on headline sector exposure alone.
