Asset-Backed Finance Is Exploding, But Diameter Capital Highlights Red Flags With The Asset Class

Investor interest in asset-backed finance, including buy-now-pay-later loans, has skyrocketed, but one big hedge fund has some warnings about it, including red flags that suggest the potential for fraud.

In their Q4 2025 letter to investors, which was obtained by Hedge Fund Alpha, Scott Goodwin and Jonathan Lewinsohn shared their insights on a multitude of sectors and asset classes, including asset-backed finance. Despite the red flags they see with ABF, they plan to boost their allocations to it in 2026.

Upside expected in distressed losers

Diameter Capital does see upside in some of its distressed losers. For example, Goodwin and Lewinsohn said they were early to the housing velocity recovery trade. They’ve been talking about a new microcycle in this area, but being early cost them in their debt holdings of Springs, a stressed window treatment supplier.

The Diameter team really likes the market structure for blinds and believes Springs’ management team is on track to halt the share loss they took when their rollout of a new product failed. Goodwin and Lewinsohn added that they are stress-testing this last assumption.

Cable

Another area in which they see promise even though they got struck during Q4 was in cable operators Altice USA and Altice International. The Diameter team said they got hit in the debt of both cable operators, which Patrick Drahi controls. He is currently moving his assets around to try to push forward some liability management transactions. The Diameter team likes their positioning in both situations and expects them to be active opportunities this year.

Looking forward to the rest of 2026, Goodwin and Lewinsohn predict another year of robust M&A activity. In fact, they think urgency could increase as CEOs consider the possibility that we might be a year closer to Lina Khan returning to the Federal Trade Commission.

Winners

Diameter Capital did have a solid win in Q4, when Environ Solutions unloaded its main business at an attractive price. The firm was also long DigitalBridge during Q4 before it was announced that it would be acquired by SoftBank. Diameter also won with Warner Bros., and the team hopes to unearth more M&A trades this year.

Large-cap pharma

Goodwin and Lewinsohn predict a surge in M&A activity among large-cap pharmaceutical names due to an unprecedented drop in drug exclusivity. They believe IG will fund that widespread M&A rush. That, alongside artificial intelligence, could press others that require capital into either the private or alternative markets, according to the Diameter team.

“We’ve all spent our careers watching every supposed leveraged finance maturity wall evaporate into dust,” Goodwin and Lewinsohn wrote. “The coming wall, mostly from PE-sponsored companies with capital structures designed for lower rates, will be no different. Instead of defaults, we’ll get more ‘capital solutions.’”