Faced with the prospect of disappointing fixed-income returns and the need to reduce equity exposure and high concentrations in corporate bonds, asset owners are more interested than ever in the spectrum of public and private credit strategies.
Using distressed debt hires as a proxy for the many variations of credit strategies, institutional investors have invested or committed a total of $22 billion through 244 transactions in the nearly five years ended Oct. 31, according to Pensions & Investments' reporting.
Commitments to distressed strategies have been increasing, P&I's data show: year-to-date as of Oct. 31, asset owners committed $4.9 billion in 56 transactions to distressed debt, compared with $4.1 billion in calendar year 2014; $3 billion in 2013; $4.3 billion in 2012; $1.7 billion in 2011; and $3.9 billion in 2010.
Among the funds that searched, committed or invested in credit strategies over the past two months:
• Pennsylvania Public School Employees' Retirement System, Harrisburg, committed $200 million to Avenue Europe Special Situations Fund III, and $100 million each to OWS Credit Opportunity Offshore Fund I and Searchlight Capital II from the $51.9 billion defined benefit plan;
• the £14.9 billion ($23 billion) Strathclyde Pension Fund, Glasgow, Scotland, is searching for a multiasset credit manager to run about £300 million and for private debt and loan managers to handle a total of up to £300 million;
• the $27.2 billion Iowa Public Employees' Retirement System, Des Moines, is searching for credit firms to manage as much as $400 million in U.S. direct loans;
• New Hampshire Retirement System, Concord, evenly allocated $151 million from the $7.5 billion pension fund among three credit funds — BlueBay Direct Lending Fund II, Gramercy Distressed Opportunity Fund III and Monroe Capital Private Credit Fund II; and
• Fresno City (Calif.) Retirement Systems split $100 million from the $2.6 billion fund between Crescent Direct Lending Levered Fund and Monroe Capital Private Credit Fund II.
Many pension funds have “very concentrated tilts toward large corporate credit cash-flow-producing investments and anything that can lessen that exposure is helpful in making their portfolios more robust,” said Christopher Redmond, a London-based director and global head of credit at Towers Watson Investment Consulting.
Credit managers often discover opportunities in less exploited parts of the global capital structure that require complex structuring to provide uncorrelated returns that are further diversifying to an institutional portfolio, Mr. Redmond said.
Over the past five years, Mr. Redmond said, demand for credit has ramped up to the extent that “everyone is trying to find these opportunities quicker than the rest of herd in the search for global yield.”
That includes Scottie Bevill, senior investment officer–fixed income and real return, for the $46 billion Teachers' Retirement System of Illinois.
“Credit spreads look great right now. It's going to be about credit going forward,” given low expected return rates for traditional fixed income, too much risk in 30-year Treasury bonds and a possible rash of corporate bond defaults, Mr. Bevill explained to trustees during his annual review of the fund's $8.1 billion global fixed-income portfolio during an investment committee meeting in late October.
The Springfield-based fund had a total of $801 million invested in 15 strategies in its special situations portfolio as of June 30, including distressed debt, direct loans and private credit. Trustees approved a plan to increase the special situations target portfolio weighting to 16% from 12%, with the flexibility to go as high as 17% of total assets. Also approved at an Oct. 30 board meeting was a $50 million commitment to Riverstone Credit Partners fund, managed by Riverstone Holdings LLC, which will make direct loans to energy-related companies.
Mr. Bevill told trustees he wants to keep “dry powder” in order to capitalize on investment opportunities in the event of a “big dislocation” in the credit markets.
The $2.7 billion San Antonio Fire and Police Pension Fund has a much smaller private credit portfolio than Illinois Teachers' — 7% of total plan assets or about $190 million — but the credit portfolio is a favorite of Matthew O'Reilly, chief investment officer.
“I'm a huge fan of private credit because of the yield spread differential relative to public markets,” Mr. O'Reilly said.
The fire and police fund initially invested in mezzanine and distressed debt, adding direct loans later, first in the U.S., then Europe and Asia. The private debt portfolio now is split evenly between mezzanine/distressed and direct loans.
Mr. O'Reilly and his team aim to make two to three commitments to private credit — of between $15 million and $20 million — in each vintage year. The relatively small size of the commitments mean “they aren't too hard to put to work,” Mr. O'Reilly said.
The private credit investment industry in the U.S. is more advanced than it is in other parts of the world, a fact that makes Mr. O'Reilly “love dealing with U.S. managers, because they have such long track records.”
That said, the investment team of the San Antonio fund for uniformed employees tries to assess private debt managers on their overall experience in this narrow market niche, not just on the quality and length of their track record.
“It sometimes comes down to a leap of faith,” Mr. O'Reilly said.