One area that has benefited is direct lending. Allocations to the asset class have accelerated in the last six months among asset owners.
In April, the $10.5 billion Orange County Employees Retirement System, Santa Ana, Calif., hired Monroe Capital LLC to run $50 million, and Crescent Capital Group LP and NXT Capital LLC to run $30 million each, as a result of the pension fund's new 7% target allocation to diversified credit managers.
“The allocation to these strategies came from reducing U.S. bond and international bond exposures,” wrote OCERS Chief Investment Officer Girard Miller in an e-mail. “We have (also) launched an exploratory search for absolute-return fixed income, without a specific funding target, in order to more comprehensively evaluate the opportunity set and the risk considerations that would accompany any further moves away from traditional core fixed income and passive bond management in particular.”
Also in April, the $20.7 billion Texas County & District Retirement System, Austin, committed $100 million to Crescent (TX) Direct Lending Co-Investment Fund, managed by Crescent Capital Group LP. The pension fund created a target allocation of 2%, which was funded by reducing the high-yield bond target to 3% from 5%.
Other pension funds that have hired direct lending managers in the past six months include the $2.2 billion San Antonio Fire & Police Pension Fund and the $1.5 billion Stanislaus County Employees' Retirement Association, Modesto, Calif.
Additionally, searches for and hiring of bank loan investment managers have increased over the past six months.
The $16.3 billion San Francisco City & County Employees' Retirement System in March launched a search for a bank loan manager to run about $100 million to complement the retirement system's existing U.S. high-yield portfolio that makes up about 8% of the pension fund's $4.3 billion fixed-income portfolio.
In January, the Rhode Island State Investment Commission, which oversees the $7.6 billion Providence-based Rhode Island Employees' Retirement System, hired Pacific Investment Management Co. LLC and Western Asset Management Co. to together run a total of $350 million to $450 million in bank loan strategies.
“The floating-rate asset class has seen a tremendous amount of flow into not just from retail and institutions but from the variations of (collateralized loan obligation) investment vehicles created to invest in these loans,” said Craig Russ, Boston-based vice president and bank loan team portfolio manager at Eaton Vance.
“Since the start of the year total inflows have approximated $50 billion, and those flows are being invested into a roughly $560 billion marketplace to put that growth into perspective,” Mr. Russ said, “and while the supply of loans has been growing, it has been more modest than the demand growth.”
Other asset owners have hired managers to invest in a variety of fixed-income and credit strategies.
For example, in March the Tennessee Consolidated Retirement System, Nashville, hired Beach Point Capital Management and Brigade Capital Management LLC to run $500 million each in the $36.6 billion pension fund's new strategic lending program.
The program, approved by the pension fund's board in September with a target allocation of 5%, has one-third each in bank loans, high-yield fixed income and other investments, which might include mezzanine and direct loans. Both new managers have a broad base that will address a range of those kinds of investments.
Fifty percent of the portfolio will be benchmarked to the Credit Suisse Leveraged Loan index and 50% benchmarked to the Barclays Capital High Yield 2% Issuer Capped index.
“I think the key thing we looked at (was) we were trying to increase the returns of the total pension fund and not take too much risk,” said Michael Brakebill, the Tennessee retirement system's CIO, in a telephone interview. “What we've done, we spent a lot of time looking at the fixed-income portfolio.”
“The (BarCap) Agg portfolio had a 1.5% expected return, (and) the longer-duration portfolio had an expected return of 2.5%. (We considered) what can we do to make a piece of that better?”
The retirement system also didn't want to increase its equity risk, Mr. Brakebill added, but wanted to go up to an expected return of 5% to 6% with the strategic lending portfolio.
“Our hope is we'll do a little better than that. Not pushing the equity too much further out and find a way to make some assets a little more productive,” he said.
In November, the board of the $6.6 billion Sacramento County (Calif.) Employees' Retirement System, which previously had a 20% target solely to domestic fixed income, approved a 15% target allocation to global fixed income, including emerging markets debt, and a 10% allocation to opportunistic credit.
The Nebraska Investment Council, Lincoln, which oversees $18 billion in assets, in February approved committing 5% to 10% of total assets to opportunistic credit. The current target to fixed income is 30%.
“Some of the conclusions are that investors are interested in unconstrained fixed income or opportunistic fixed income, and you know I think there is no one definition of that,” said Andrew Johnson, Chicago-based CIO for investment-grade bonds and portfolio manager of the strategic income strategy at Neuberger Berman. “That is not homogeneous. You could probably ask 10 people what that is and get 10 different answers.”
“Maybe a way to think about opportunistic, I sort of gave a pyramids analogy, the base being traditional core-plus or core-plus-plus, essentially core-plus with a higher risk budget,” Mr. Johnson said. “Your layer on the next portion of the pyramid would be a more active duration management i.e., expending the duration band potentially to include the ability to be negative durations; the next building block would be pure alpha strategies, maybe diversified currency or maybe some long/short vehicle.”
More asset owners are also exploring emerging markets debt because the central banks in those fast-growing countries have not adopted quantitative easing as developed countries have.
Scott Day, director of risk management, fixed income and capital markets, at Wurts & Associates Inc., Seattle, says they're championing emerging markets debt due to the “diversification of central bank risk factors.”
“It's (emerging markets debt) now yielding more than high yield, (but) our viewpoint isn't (that) we haven't liked it necessarily because of the yield enhancement. (We) more like it because of the diversification of risk factors. Emerging markets central banks are different situations that are not battling the same battle,” Mr. Day said.
In April, the $3.2 billion Fresno County (Calif.) Employees' Retirement Association hired PIMCO. as its first emerging markets debt local currency manager, running about $110 million.
“We're definitely looking for yield, not expecting to get a lot of wind in our sail from U.S. domestic market on the core side,” said Phillip Kapler, retirement administrator of the Fresno County pension fund. “It's probably smart to go where the rates are higher and (means) at least there's going to be some chance of generating meaningful returns.”