The trend is relatively recent, but seemingly accepted and reasonably well established: from its roots as part of alternative asset or fixed income allocations, private debt has grown sufficiently as an asset class in its own right to merit separate treatment. These days, the private debt bucket is a phenomenon that is no more unusual than the private equity or real estate buckets.
At first glance, therefore, the decision by PensionDanmark – one of Europe’s largest pension funds, with €31.5 billion of assets under management – to merge its private debt capabilities into its wider alternative assets team appeared puzzling. In the private debt world, separate LP allocations are seen almost as a badge of honour – a form of recognition from investors that private debt has reached an acceptable level of maturity. Why would a substantial player like PensionDanmark appear to buy into this, only to backtrack?
The answer, according to the organisation’s new head of alternatives, Kim Neilsen, lies in flexibility to target different parts of the capital structure in order to achieve the risk-adjusted return that the pension fund is seeking. He told PDI in a recent interview:
“Transactions and market dynamics change all the time, and it may be possible to achieve better risk-adjusted returns by investing in a structured debt or equity tranche than outright investing in either equity or senior debt.”
It is, in other words, about flexibility in achieving the end goal rather than attempting to be zealously faithful to what constitutes a private debt or private equity transaction – and, consequently, which bucket the capital should be drawn from.
The broader context is the need for pensions to retain a sharp focus on risk-return profiles, and how they may need to shift as members age and have traditionally shifted towards lower-risk and lower-yielding investments as they get nearer to retirement.
Pensions have long experience of how to achieve this transition successfully, but the market volatility of recent times – combined with historically low interest rates – have created challenging conditions for investing in which useful precedents are few and far between. With the pieces of the puzzle thrown in the air, PensionDanmark will not be the only pension examining whether its current structure is the optimal one to meets its targets.
Nielsen believes that PensionDanmark’s new set-up will allow it to more precisely target different parts of the capital structure and boost its ability to come up with the right investment mix. Other institutional investors will no doubt be closely examining what it has done, and how it fares in the future. Don’t expect there to be a widespread rejection of the separate bucket approach; but neither should it be assumed that it’s the only way to go.
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