The prospect of a low-return environment over the next decade is pushing a wide swath of institutional investors to increase allocations to private credit strategies at the expense of core fixed income and equity.
With expected annualized returns of about 5.4% for a well-diversified institutional portfolio over the next 10 years, sources said it will be difficult for asset owners to meet assumed rates of return of 7% or higher without moving more assets into less liquid, non-publicly traded credit instruments.
"It remains difficult to get to a 7.5% return. The continuing search for yield is leading investors to strategies outside traditional core fixed income," said David L. Lindberg, a Pittsburgh-based managing director and senior consultant at Wilshire Associates Inc.
Those strategies include direct lending, distressed and opportunistic debt, real estate debt, structured products and more esoteric areas such as aviation financing and equipment leasing, all of which share some degree of illiquidity. Fund structures vary from long-locked private equity vehicles with a 10- to 12-year investment period to hybrid variations of the private equity model with typical lock ups of between three to five years.
"There aren't a lot of tricks left in the bag. I wish I could tell you there is a magic solution, but there isn't," said Sue Crotty, senior vice president and multiemployer practice leader at Segal Marco Advisors, Chicago, noting that the firm's Taft-Hartley plan clients have steadily moved assets into credit strategies over the past two years in the search for incremental returns.
The push into private credit by pension funds isn't new — assets managed in private debt funds rose 59.5% to $638 billion in the five years ended Dec. 31, data from Preqin Ltd. showed — but the pace is expected to sharply accelerate.
Institutional investors, banks and insurance companies were significant contributors to industrywide asset growth: 49% of fixed income chiefs said they raised their allocations to private credit at the expense of government bonds during the previous three years, a recent survey of the heads of fixed income at 79 defined benefit plans, defined contribution plans, sovereign wealth funds, banks and insurance companies by Invesco Ltd. showed.