Private credit assets show no signs of slowing down in retirement plans as pension funds continue building up allocations.
But chief investment officers point to concerns over significant growth in the space and new entrants that haven’t been tested through different market cycles. Credit spreads, too, are tightening.
Defined benefit funds of the 200 largest U.S. retirement plans reported $198.4 billion in private credit assets as of Sept. 30, up 57.2% from $126.2 billion a year prior. Private credit has seen a huge leap in recent years from only $26 billion five years ago, according to P&I data.
The growth in private credit assets continued at a steady pace, up from the 29% growth seen a year earlier.
Many investors began allocating to private credit with direct lending allocations, said David Scopelliti, global head of private markets at Mercer.
“Like Baskin Robbins, there’s 31 different flavors of ice cream … I don't know if there’s quite 31 different flavors of direct lending, but there’s a large market, the middle market, the lower market, the micro market. There’s a bunch there,” he said, pointing to diversified direct lending vs. healthcare or venture direct lending.
Investors are increasingly looking to other segments of private credit, especially multiasset-backed finance, and while in its early days, credit secondaries are also gaining attention, Scopelliti said.
Allocations vary based on funded status, with some fully funded plans allocating to investment-grade credit in case they want to pursue a pension risk transfer, while underfunded plans are looking for yield, he said.
“A lot of those (not fully funded) investors definitely are using private credit as a yield enhancement,” Scopelliti said. It's a "return enhancement for their broader portfolio, and we're seeing allocations move from fixed income in particular.”
Opportunities in middle market, asset-backed
The Public Employees Retirement Association of New Mexico began allocating to private credit in 2017 and expects an 8% to 10% net return over a market cycle and a “meaningful spread over liquid credit,” said CIO Michael Shackelford in an email, noting that so far, private credit has performed as expected.
The $17.5 billion pension fund saw one of the largest private credit increases in P&I's survey with its portfolio increasing over 500% during the survey period. The plan has a target allocation of 8%, or about $1.5 billion, and as of Sept. 30 had a 3.8% actual allocation, Shackelford said.
“Although spreads have tightened, we continue to see opportunities in core middle-market direct lending. We also see the opportunity set expand in asset-backed finance as banks and nonbank lenders continue to access it for balance sheet optimization and capital relief,” Shackelford said.
He noted he’s keeping an eye out for degradation of creditor protections and asset/liability mismatches in retail products in the space.
Jonathan Glidden, CIO of Delta Airlines, is also looking to do more in asset-backed finance. Delta saw its private credit assets grow a little over 23% during the survey period to $1.4 billion.
Delta first incorporated private credit as part of its strategic asset allocation in 2017 and has been growing it from 5% to a 10% target that it is now approaching, he said. The plan uses five buckets: direct lending, corporate securitized, residential, commercial real estate, and asset-backed, Glidden said.
While Glidden too has concerns over spreads tightening, he remains positive on private credit.
“I’m optimistic for private credit relative to other asset classes today,” he said.
Senior credit
The Florida State Board of Administration, Tallahassee, has invested in private credit for more than 20 years, first starting with allocations within its private equity asset class that were more opportunistic and distressed oriented before creating a new asset class — strategic investments — after the global financial crisis that housed credit investments, said John Mogg, senior investment officer of active credit.
Last year, the SBA created a new asset class called active credit that includes both private credit as well as multiasset credit. Going forward, all private credit investments will be made in the new asset class.
“The asset class over the last 20 years has really grown quite a bit, and it's really become an institutional asset class. And so we decided, instead of taking a more opportunistic approach and periodically surveying the market and forecasting where we saw the opportunities, we thought that it really made sense to have a dedicated allocation,” Mogg said, adding that within active credit there’s a targeted 4% private credit allocation and 3% to multiasset credit, which contains more liquid return-seeking credit opportunities. Florida SBA had $205.2 billion in defined benefit assets as of Sept. 30.
As part of the new portfolio construction framework for private credit — more focused on senior, top of the capital structure, lending income as well as less volatility — the plan executed a credit secondaries sale, Mogg said. Excluding those assets, Florida had $7.3 billion in private credit as of Sept. 30.
“We took the portfolio to market and sold it, and now we’ll be looking to reposition into other credit investments more in line with what the target is for this new allocation,” he said, adding, “with this new active credit asset class and the private credit mandate within that we’re much more targeted, we want to be much more income-oriented.”
Mogg added, “with rates going up… we feel it’s prudent that we can invest top of the capital structure, take less risk, generate a healthy income for the pension.”
Others are also looking to senior credit.
The $59.5 billion Connecticut Retirement Plans & Trust Funds, Hartford, saw its private credit assets increase 55% to $3.1 billion for the year ended Sept. 30.
Connecticut established its private credit allocation in early 2020 with an initial target of 5%. That was revised in September 2022 to a 10% target.
The plan’s private credit portfolio targets exposure across three broad subcategories, with the most exposure in performing senior credit and the balance split between mezzanine and special situations, said CIO Ted Wright in an email. He said he continues to see opportunities to scale these positions while also potentially adding diversifying exposure in royalty finance and credit secondaries.
“Our portfolio construction objectives are already heavily skewed toward performing senior credit; however, the current rate environment might cause us to lean slightly more into senior strategies because of the attractive return profile available for taking senior secured credit risk,” he said.
Wright said that significant growth in private credit over the last decade has led to concerns about the market growing too quickly.
“At the macro level, we believe structural changes driven by the diminished role of commercial banks in traditional credit markets continue to create a growing opportunity for private credit investment,” he said. “At the micro level, we seek to mitigate any potential concerns by remaining focused on private credit managers with a very strong, fundamental credit culture, particularly firms led by teams that have had the experience of investing through less benign market conditions.”
Slow, cautious approach
Iowa Public Employees’ Retirement System saw a 22.9% increase in its private credit assets over the survey period to $2.7 billion. While the $45.3 billion system is still underweight its 8% target, CIO Sriram Lakshminarayanan is advocating a slow and steady approach to the asset class.
“Private credit does have a place in the global financial system, and it is not something that’s going to go away anytime soon. It’s not bad,” he said. “So it makes sense for us to think about this as a longer-term allocation and not be worried about what private credit might do in the next year or two years.”
Lakshminarayanan’s approach has been to allocate at a slow and steady pace and to make sure investment team and board understand what they are investing in because he views private credit as an “evolving” space.
“One is, don't be in a hurry. And two is, use as many partners as you can to conduct your operational due diligence,” he said, adding, “Don't be rushed into an investment where somebody’s closing a fund in a month. You know, there's always going to be available business.”