Direct lending partnerships between sovereign wealth funds and money managers are becoming a neat way for state-owned pools of capital to gain access to direct lending opportunities and maintain exposure to regions where public markets look expensive.
Committing capital to private markets strategies is nothing new for sovereign wealth funds, but the structure of three deals last year are particularly interesting, sources said.
In September, the $232.2 billion fund Mubadala Investment Co., Abu Dhabi, partnered with Barings LLC to provide financing to European middle-market businesses through the Barings Mubadala Enterprise.
The partnership, which invests alongside Barings parent firm Massachusetts Mutual Life Insurance Co., aims to provide $3.5 billion in financing over the next 18 months.
The agreement followed the formation of Apollo Strategic Origination Partners — an origination platform partnership between Mubadala and Apollo Global Management Inc. — which is expected to provide about $12 billion in financing over the next three years. It targets deals of about $1 billion and will originate opportunities on a global basis. The platform will target scaled investments in large, established corporations.
Also in September, the $295 billion Qatar Investment Authority, Doha, formed a multibillion-dollar direct lending platform with Credit Suisse Asset Management. The platform focuses on first- and second-lien loans to upper midmarket and larger companies in the U.S. and Europe. QIA is a significant shareholder in Credit Suisse Group AG.
Spokesmen at Mubadala and Apollo were not available to comment. Spokesmen for Credit Suisse Asset Management and Barings declined to comment. Spokesmen for QIA did not respond to requests for comment.
Funds have tried to invest directly in challenging asset classes such as direct lending in the past, but research by the International Forum of Sovereign Wealth Funds "found that it was difficult for them to resource," said Victoria Barbary, director of strategy and communications at the forum in London. "These private lending joint ventures are almost the new co-invest. They are trying to learn about a new asset class that they haven't done much in before, (but) they don't have access to the market as much and deal flow in the space. It's helpful for them to create these more peer-to-peer-type structures rather than GP/LP where the power balance is slightly different," Ms. Barbary said.
Sovereign wealth funds were "not particularly active in direct lending previously," said Enrico Soddu, head of data and analytics in London at the IFSWF. Ms. Barbary added that because of this, creating a partnership "is to a degree a safer way of introducing themselves to a different asset class rather than what we saw a decade ago. This change in structures is interesting in that it's indicative of an increasing sophistication of these funds."
Embarking on private credit partnerships with money managers is no new thing for some of large Canadian pension funds, for example. In 2016, Public Sector Pension Investment Board, Montreal, made a €500 million ($609 million) seed investment in Albacore Capital Group's European credit platform.
The attraction of direct lending and private debt for sovereign wealth funds is much the same as that for other types of institutional investors: "Diversification and higher yields, in the context of volatile public equities, overpriced private equities and a difficult environment for bonds," said Diego Lopez, New York-based managing director at Global SWF, a firm that tracks sovereign wealth funds and public pension funds.
The European focus for the Mubadala/Barings and QIA/CSAM partnerships shows "a desire to continue to have some form of exposure to Europe because of the underlying fundamentals," the IFSWF's Ms. Barbary said. Since European equity markets have held up well and are still quite expensive, gaining exposure to the region via private debt and private equity may be a more attractive route, she said.
And, of course, there is also a COVID-19 story involving the partnerships "because there are loads of companies that, given lockdown, are viable businesses in even vaguely normal times, but just not right now. There's an opportunity to lend to companies that are not distressed but have been hit by COVID," Ms. Barbary added.
The direct lending market experienced a slowdown in line with other markets as the coronavirus pandemic bit in the second quarter last year. Deloitte LLP's Alternative Lender Deal Tracker found that second-quarter European deal activity was down 58% vs. the same period in 2019.
However, in the first quarter, Deloitte recorded the highest first-quarter deal volumes on record, with 12.2% more than in the first quarter 2019. And the third quarter of last year brought with it a relaxing of restrictions across Europe, resulting in a 30% increase in deals vs. the previous three months. Looking ahead, Deloitte said positive developments for vaccines are unlikely to have an impact on the direct lending market until the first quarter of this year.
Managers expect direct lending to continue to offer opportunities. "There are quite a few opportunities as central banks have been quite reluctant to get involved in direct lending," said Anton Pil, global head of alternatives at J.P. Morgan Asset Management in New York. "Probably a year ago, pre-pandemic, I was getting worried about valuations in private credit, but those have widened back out."
And investing through a partnership means sovereign wealth funds "get access to the distribution capabilities of their partners, which they could not do alone," said Rod Ringrow, London-based head of official institutions at Invesco Ltd. "So a win-win for both the originators and the capital providers."
Regarding the potential risks and losses associated with direct lending, such as defaults, Mr. Ringrow said he assumes that, as these partnerships "are investing across a wide spread of underlying clients, then perhaps viewing it as a total pool and recognizing the return on the total pool — rather than each individual underlying loan — would allow them to account for this issue."
Global SWF executives expect to see more sovereign wealth and public pension funds "look for further opportunities in debt default risks," Daniel Brett, head of research and data at the firm in London, wrote in an October newsletter.
There is a risk, however, that "an investor bandwagon could see capital deployed too early, leading to unattractive valuations as investors compete to snap up opportunities. Nevertheless, state-owned investors are quick learners and have sufficient weight and sophistication to dominate the market going forward," he said.
But creating a direct lending partnership won't be a blanket opportunity for sovereign wealth funds. "You're only talking about six to 10 funds that have the ability to do this out of a universe of 78. They are the bigger funds," Ms. Barbary added.
