Feature – Private credit
And while most institutional investors would not like to see themselves as shadow bankers, their lending activities have become a cornerstone of the market. In the UK, pension funds account for more than 9% of non-bank financial intermediation, according to the Financial Stability Board. If indirect investment through asset managers is considered, the number is signifi- cantly higher. Preqin estimates that public sector pension schemes now account for some 20% of private credit investments globally, with another 10% held by public pension funds. Insurers and charitable foundations are also significant players with 13% and 9% stakes. Private credit has taken a growing share of pension fund portfolios with private credit allocations among defined benefit (DB) schemes grew to 21% from 16% during 2021, according to Mercer. And some 20% of schemes told the consul- tancy that they intend to continue to increase exposure.
Alternative income The appeal of private credit, particularly to mature defined ben- efit schemes, is clear. It offers a steady stream of cash at a time when traditional bonds have turned from fixed income to no income. As such, private credit has become a popular element of growth-oriented portfolios and is commonly used in liability- driven investing (LDI) strategies. Some larger funds, such as USS and the Pension Protection Fund (PPF), have established in-house research capacity to access the sector. “We have split private credits into parts,” says Purna Bhudia, the PPF’s head of credit. “Part of our private credit portfolio has been in-sourced, but we also use external managers because we understand that we will never have the breadth to cover everything.”
“When looking at private credit, we first established our goals at the PPF and then matched our investment positioning to meet these goals,” Bhudia says. The fund uses a combination of investment grade private credit on a buy-and-hold basis as part of its LDI strategy and high-yield private credit in its return ori- ented profile, which is externally managed. Other pension funds, such as local government pool Border to Coast, have opted to outsource their strategy. The £55bn pool announced more than £500bn in private credit investments in May last year, spread across six external managers, followed by another £208m investment in private credit at the beginning of this year, suggesting that the appetite for private lending among its partner funds continues to grow. London CIV, another local government pension pool, also sees increased demand for private markets among its partner funds. The pool has launched four private market funds during the past year and another £92m private credit fund at the end of March. Are these funds concerned about the impact of monetary tight-
32 April 2022 portfolio institutional roundtable: Fixed Income
ening? Bhudia stresses that private credit might not be directly affected. “Private credit in itself remains attractive first because the risk-adjusted returns are steady and you get an illiquidity premium but you also get access to securities, such as secured property loans, that you would not get in the public market. “We are cognizant that there will be more volatility as we figure out how the central banks will move in this environment,” she adds. Evan Guppy, head of LDI at the PPF, says that the fund uses pri- vate credit as a hedge. “What happens is that we will match our liabilities to what we are expecting to pay our pensioners. If interest rates move, our liabilities move too. “That’s why interest rates do not matter as much because even if the asset values move, our liabilities have also moved to an equivalent amount,” he adds.
Private credit also plays an important part in hedging against inflation risks at USS, says chief investment officer Simon Pilcher. The £82.2bn fund has expanded its private markets team to 60 people and invests in a combination of infrastruc- ture, private equity and debt.
Dry powder An indication of investor appetite are the extraordinary levels of dry powder. By the end of 2021, the level of capital that is yet to be deployed sat close to $400bn (£303bn), accounting for almost half of the world’s private credit allocation, according to Preqin. The data provider stresses that high levels of dry powder are not necessarily a cause for concern. In the immediate aftermath of the global financial crisis, the level of capital yet to be invested
We are cognizant that there will be more volatility as we figure out how the central banks will move in
this environment. Purna Bhudia, Pension Protection Fund
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