3 Trends Shaping Financial Sector Investing

Banks, asset management firms, companies and investors are finally seeing capital markets activity begin to thaw, after months of hesitation driven by uncertainty around U.S. tariff policies and market volatility. While most financial sponsors and corporates adopted a wait-and-see approach on mergers and acquisitions and initial public offerings in the first quarter of 2025, windows of opportunity are beginning to open, especially for companies with limited exposure to supply-chain disruptions.

Market participants in the U.S. financial services industry are also watching the consumer backdrop, which is mixed: Inflation is putting a strain on lower-income households, while discretionary spending on higher-ticket items shows signs of softening. Still, overall consumption remains resilient, for the time being.

At the 2025 Morgan Stanley U.S. Financials Conference, three key investing themes stood out based on discussions from top company executives and investors about the macroeconomic environment, capital markets activity and growth opportunities for companies:

1.      A long-awaited rebound in M&A and IPO activity

2.      High demand for investment-grade private credit

3.      Growing interest in asset-backed finance

Waiting for M&A and IPO Rebounds

U.S. banks, asset managers, companies and investors are watching closely for signs of a sustained rebound in M&A and IPO activity, which can stimulate more transactions in capital markets, including debt issuance for acquisition financing such as term loans, high-yield bonds and private credit.

Already in the first quarter of 2025, M&A has shown signs of building momentum. Announced deal values rose 8% over the prior quarter and 15% over the prior year, with the U.S. composing 58% of global activity.¹

Executives at the conference said they expect private equity firms to drive a significant share of future deal volume because of their record levels of dry powder and the pent-up supply of assets from delaying exits. The average age of sponsor portfolios is historically high and monetizations will need to happen to allow for new fundraising.

Banks are positioning to gain market share with financial sponsors to win M&A advisory mandates and facilitate sales and acquisition financing. “Companies and investors are watching for a real unlocking of the M&A market, and many expect that sponsors will be a big driver, in addition to corporate M&A,” said John Esposito, Global Head of Financial Institutions in Investment Banking at Morgan Stanley.

On the IPO front, companies with business models that are relatively insulated from trade and supply-chain disruptions are finding windows to go public. But for other corporates, the macroeconomic uncertainty has made it difficult to offer a three-to-four-year earnings forecast and therefore challenging for investors to value companies. Some executives at the conference said that sponsor-backed companies may opt for M&A instead of IPOs as an exit route, because of these challenges.

Demand for Investment-Grade Private Credit

Private credit continues to attract strong demand from institutional investors, and banks and asset managers at the conference cited it as one of the biggest opportunities for growth. The size of the private credit market at the start of 2024 was approximately $1.5 trillion, compared to approximately $1 trillion in 2020, and it is estimated to grow to $2.8 trillion by 2028.²

Bank and asset management executives highlighted a growing appetite for investment-grade private credit, in particular. Investment-grade private credit offers a yield premium over similarly rated public bonds because it is less liquid and privately negotiated. For investors, it could mean higher returns for similar credit risk, with tailored terms and lender protections. For borrowers, the financing offers more customization and flexibility when it comes to repayment schedules, covenants and structuring around events like acquisitions or refinancing.

Banks and asset management firms are positioning to meet this demand. “Firms are expanding their private credit platforms to originate, underwrite and distribute the debt at scale,” said Liz Jacobs, Head of Banks in Investment Banking at Morgan Stanley. “For banks and asset managers, it’s a major area of opportunity.” One bank CEO said that that the market is lacking enough private credit supply, while an asset management executive called investment-grade private credit a core pillar of future growth. As an example of issuance, one speaker cited a data center developer needing capital and choosing to offer investment-grade private credit to attract institutional investors looking for longer-term, higher-yielding and low credit-risk assets.

Though private credit offers attractive yield and stability, another executive highlighted its potential risks. Ongoing tariff-related pressures and a potential slowdown in economic growth could push up default rates. Compounding that risk is the leverage used by many private credit funds to enhance returns. In a strong U.S. economy with low defaults, using leverage to increase yield is more benign, but in a weaker environment, it can amplify losses and reduce fund liquidity.

Asset-Backed Finance Gaining Traction

Asset managers highlighted another type of private credit in demand from institutional investors: asset-backed finance (ABF), or lending that is secured by pools of underlying assets such as consumer loans or auto leases. The global private ABF market totals $5.2 trillion, which is 15% larger than in 2020 and 67% larger than the previous peak of $3.1 trillion in 2006, with growth projections estimating a size of $7.7 trillion in the next five years.³

One executive noted that asset-backed finance can offer multiples of the deployment capacity of corporate direct lending, making it a powerful tool to meet the growing institutional demand for private credit. Unlike direct lending, which is tied to corporate balance sheets, asset-backed finance is secured by pools of underlying assets and diversified across hundreds or thousands of loans, which may mean lower risk than debt tied to a specific borrower. Institutional investors, especially insurance companies, are drawn to asset-backed finance because of its relatively predictable cash flows and flexible structuring of risk and yield. When offered through separately managed accounts, ABF can also provide customized liquidity terms.

“In today’s market, in which volatility and continuing high interest rates are shaping investor priorities, asset-backed finance is gaining real traction,” said David Heaton, Chairman of Asset Management Investment Banking at Morgan Stanley. “Institutional investors are looking for rated assets that offer diversification, steady cash flows and higher yields.”