2017: UK LGPS to pile into private debt

ESG concerns remain at a low level for fund managers in private debt, but as more UK pension schemes are expected to enter the market next year it is likely to become a higher priority.

Traditionally considered the more conservative institutional investors, UK local government pension schemes are beginning to see the benefits of private debt. A number of LPGS dipped their toes this year, while others are preparing to up their allocations.

It’s a sign of the asset class’s maturity that it has been able to win over these pension funds and a vindication of the network of advisors, placement agents and fund managers who have worked hard to promote the benefits of the asset class over the last couple of years.

And in 2017 many are expecting to see this trend continue. Niels Bodenheim, director of private markets at bfinance, which advises UK LGPS on their investments in private debt, is confident of further successes for fund managers. “We are going to see more activity in this space as people are increasingly interested in the senior debt space. But we are going to see more emphasis on the fund products as we see increasing competition in this market.”

London-headquartered pan-European senior unlevered funds remain the preference for UK LGPS. But, increasingly, concerns surrounding environmental, social and governance are becoming a bigger factor when investors pick their fund managers, especially as they look to distinguish among strategies in the crowded senior space.

To win over the socially concerned, however, is not a matter of avoiding the “sin stocks”, but taking an active approach to monitoring the behaviour of portfolio companies. Holding a PRI certificate is no longer sufficient. In a recent report on ESG by bfinance, author Kathryn Saklatvala, global content director, said: “The number of ESG offerings continues to rise and the marketing has become more sophisticated, but it’s increasingly challenging to distinguish between box ticking and substance.”

Each investment a LGPS makes faces public scrutiny and navigating such a focus is not easy. One only needs to look at the controversy over the Suffolk County Council Pension Fund’s decision to maintain its investment in the stock of British American Tobacco in the local press as an example. Commercial considerations are a hard argument to make in the wake of public health concerns for these public-facing bodies.

Reflecting this trend, fund managers are managing strategies with ESG as a higher priority. The Environment Agency Pension Fund recently allocated £60 million to Permira’s third debt fund. Citing it’s “organisational commitment to responsible investment” as a reason for committing to the vehicle, as well as its “focus on senior loans with moderate leverage” and its “track record” that also added to its attraction.

Responsible investing is a key factor in LGPS’s decision, but it is not a rigid approach that investors are looking for. Yield is the number one concern as UK pension funds face record deficits, which means it’s not surprising that many have switched to private debt – and many more are expected to do so in 2017. Still, there is no downside to obtaining a PRI certificate.