Consultants are steering pension fund clients into leveraged loans and other forms of credit, investments that can cut across asset classes to take advantage of the global need for financing.
Among the investors:
c The $7 billion Michigan Municipal Employees' Retirement System, Lansing, in May restructured its $2 billion fixed-income portfolio, moving all but $770 million into private credit strategies.
c The $1.8 billion Denver Employees Retirement Plan in May invested $50 million in a private senior loan portfolio with Golub Capital.
“Investors are increasingly interested in deploying capital in multiasset class strategies where the manager can make tactical asset allocations to take advantage of market inefficiencies and illiquidity,” said Mark Attanasio, managing partner with Los Angeles-based Crescent Capital Group. The firm is in the process of bringing in a team to start a direct-lending business. Crescent has a strategic partnership with the $25 billion South Carolina Retirement System Investment Commission, Columbia, to invest $750 million in opportunistic credit strategies.
In the past year, investors that had been flirting with leveraged loans and credit investment began defining opportunistic credit allocations and making investments.
Since the 2008 global market meltdown, institutional investors have been providing credit that had been the job of banks and financing companies, said Janine Baldridge, Russell Investments' managing director, alternative investment consulting practice, based in Seattle.
“We have been working with clients who are implementing multiasset, multimanager credit investments in a combination of funds and separate accounts,” Ms. Baldridge said.
Investor objectives for the credit portfolios vary. Some are adding credit as a hedge against rising interest rates and for diversification. Other investors are looking to enhance their portfolio returns, she said.
New to pension funds
Some credit investments are new to pension funds, which had invested in core and core-plus fixed income but never before ventured into leveraged loans, said William C. Sonneborn, CEO of KKR Asset Management, San Francisco.
“None of the fixed-income mandates included leveraged loans because loans are contracts and not securities,” he said. “They were outside pension funds' mandates.”
A number of consulting firms — including NEPC LLC, Hewitt EnnisKnupp Inc., Pension Consulting Alliance Inc. and Summit Strategies Group — have been bringing the investment strategy to pension fund clients that are moving money out of fixed income or equity.
One pension fund checking out the strategy is the $5 billion San Diego City Employees' Retirement System. Its general investment consultant, Hewitt EnnisKnupp, is recommending a commitment to bank loans, another term for leveraged loans.
“Given current market environment ... there is a compelling case to consider bank loans,” Hewitt EnnisKnupp noted in a May report to the pension fund's investment committee. In the current low-yield environment with the risk of rising interest rates, bank loans “offer a favorable spread, with seniority in capital structure and provide a hedge against rising rates.”
Liza Crisafi, CIO of the San Diego fund, could not be reached for comment by press time.
Lennox Hartman, Hewitt EnnisKnupp principal and head of global fixed-income research based in London, said his firm believes “loans will do well in a positive-growth, rising-rate environment. Loans are floating-rate instruments linked to LIBOR and hence, as interest rates rise, so too do the coupons from loans. This is different (from) fixed-rate instruments (e.g., high-yield bonds) whose value falls as rates rise, all else being equal.”
Clients in the U.S. and Europe have been showing an increased interest in the asset class, he noted. “As with most forays into new opportunities, there is a long lag in terms of buy-in. Loans are starting to get more momentum. ... We are going out and speaking to more potential investors and clients than we had six to nine months ago,” he said.
And the strategy is becoming increasingly global, with U.S. firms buying European ones. In January, GSO Capital Partners, the credit business of New York private equity firm Blackstone Group, acquired London-based Harbourmaster Capital, a European leveraged loan manager. Last August, Los Angeles-based Ares Management LLC bought London-based credit manager Indicus Advisors.
Pension Consulting Alliance also favors investment in private credit strategies now.
“In our opinion, direct lending funds have been gaining favor in recent years due to the lack of traditional sources of credit for middle-market companies, combined with the relative underperformance in the large buyout sector,” said Andrew M. Bratt, principal in PCA's La Jolla, Calif., office.
Credit strategies also help investors add an income component to their alternative investment portfolios, Mr. Bratt said in an e-mailed response to questions. “This strategy also makes sense for institutional clients seeking to mitigate the J-curve typical in private funds that do not make frequent distributions of income,” Mr. Bratt said.
Institutional investors are searching for current income, said Theodore “Ted” Koenig, CEO of Monroe Capital LLC, Chicago, a debt investment management firm. “Private equity is not a current yield business. ... We are and have always been all about current yield. That has become a much more sexy business to investors right now.”
The Oregon Investment Council, Tigard, which manages the $58.4 billion Oregon Public Employees Retirement Fund, Salem, was one of the earliest investors in private credit. Its initial $2.1 billion commitment in August 2008 for a low-investment-grade credit portfolio helped launch KKR & Co. LP's credit business. Oregon followed up with a $1.3 billion commitment in July 2009 to Oak Hill Advisors LP. Both investments are in the council's $13.4 billion fixed-income portfolio.
In February 2011, the Oregon council committed $100 million from its opportunity portfolio to TPG Specialty Lending Inc., a private direct lending strategy, Michael G. Mueller, interim CIO of the Oregon State Treasury, Tigard, wrote in an e-mail.
So far, both KKR and Oak Hill have outperformed the council's custom leveraged loan and bond benchmark, but not by much. KKR's portfolio surpassed the benchmark by one to two percentage points in the three-, two- and one-year periods ended April 30, according to a recent State Street Investment Analytics report to the board. Oak Hill's portfolio has outperformed the benchmark by close to a percentage point for the two years and year ended April 30.
At this point, staff is satisfied with the performance of both firms.
“From staff's perspective, as a diversifier and inflation/rising rates hedge in the current fixed-income environment, it has been a positive in absolute and relative terms,” Mr. Mueller wrote.
The New Mexico Educational Retirement Board, Santa Fe, is gaining exposure to private credit in a number of areas throughout its opportunistic credit portfolio. Officials are in the process of concluding the contracts for new emerging markets debt managers Gramercy Advisors LLC and ICE Canyon LLC. Both managers are expected to include private debt in their portfolios, said Bob Jacksha, chief investment officer of the $9.6 billion fund.
The New Mexico Educational fund also has committed capital to loan managers, which might include non-syndicated private debt, he said.
In November, fund officials expanded GoldenTree Asset Management's $100 million portfolio to include leveraged loans, high-yield bonds, distressed debt and some “credit related” equities. The mandate had been limited to collateralized loan obligations.
Investing in private debt is part of the fund's general theme of stepping into areas where credit providers have stepped back, Mr. Jacksha said.