Diving into the pool

Some London pension funds have decided to move into the private debt fast lane. There are risks, but they’re right to do so.

While the UK is the world’s second-largest private debt market, and comfortably the largest in Europe, the country’s limited partners have been relatively slow to embrace the asset class.

PDI data reveal that, based on size of allocations to private debt, only one UK LP edges into the top 10 – CDC Group, the development finance institution. While a couple of corporate pension schemes – BBC Pension Trust and British Coal Staff Superannuation Scheme – make the top 20, the highest ranked public pension fund is East Riding of Yorkshire County Council at number 31.

However, one recent development suggests there is appetite for the asset class from within the UK public pension ranks – and that they are thinking of innovative ways to access it. In 2015, UK local authorities began pooling their resources under the Local Government Pension Scheme to bring together 89 separate pension funds across England and Wales to give them greater purchasing power.

As a subset of the LGPS, funds in London have been brought together under the London Collective Investment Vehicle, covering 33 local authority pension schemes. In the early days of this pooling exercise, the investment focus has been on long-established and liquid asset classes. But a group of five funds – for the London boroughs of Ealing, Havering, Lambeth, Wandsworth and Merton – decided they wanted a shortcut into private debt. So they got together – outside of the LCIV structure – and put together their own private debt mandate.

The mandate, advised by consultant bfinance, is worth a fairly substantial £250 million ($338 million; €285 million), accounting for 5.5 percent of the five boroughs’ total assets under management. Capital for the scheme has been reallocated from both fixed income and equity allocations. The key drivers appear to be diversification and wanting to put less emphasis on capital growth and more on income.

One factor in the decision appears to have been the stock market volatility seen earlier this year, which has made investors nervous about being exposed to equities heavily reliant on asset growth to bolster returns. The funds have concluded that private debt will enable them to cut their risk exposure and still achieve strong asset-backed returns.

While it may prove a one-off, the chances are there may be many other local pension funds mulling similar moves. The five boroughs have said their scheme is open for others to join and give a boost to the total capital available for investment. It would not be surprising if some funds took them up on the offer.

With so much talk about the end of the credit cycle, taking a first big stride into private debt now is not without its risks. This risk can be amplified by new LPs making their first moves into parts of the market that are highly competitive. But assuming they are given wise counsel regarding the need for diversification, the London boroughs may come to be seen as pioneers of UK local pension engagement with private debt.