Friday letter: The North American model

In the US and Canada, investors have set strong examples of how getting into private debt directly could work for European institutional investors that are looking for good risk-adjusted returns.

Earlier this week the State of Wisconsin Investment Board discussed whether to expand its existing private debt programme to the wider Midwest. The board, which manages the assets of the Wisconsin Retirement System, the State Investment Fund as well as other state trust funds, has had a credit programme in place since the 1960s. It lends directly to mid- and lower mid-market companies in need of both senior and subordinated debt in Wisconsin. It has also lent outside the state in neighbouring Minnesota, Iowa, Illinois and Michigan. 

After deploying about $2 billion across 200 deals in its own back garden, the investor is now eyeing an expansion of the programme to other Midwestern states including Indiana, Ohio and Pennsylvania.

The boost this credit scheme provides to the local real economy is a happy coincidence for the state board, its main motivation are returns, which have been good. The state’s private debt holdings beat their benchmarks on a one-, three-, five- and 10-year basis up to 31 March 2014, according to the investment board’s financials published last year. The full 2014 results have not yet been published but in the period ending March last year, the one-year return was 3.5 percent, while the portfolio generated 12.6 percent on a five-year basis. 

Wisconsin isn’t the only North American investor to have flexed its muscle as a direct lender. One of Canada’s largest pension funds, Canada Pension Plan Investment Board, lends directly in both liquid and illiquid instruments, while US insurer MetLife has carved out a significant lending business across asset classes too. 

In Europe, the situation is different with few investors, so far, venturing into directly originated credit. Insurer Prudential’s M&G Investments is one exception but generally European investors have stuck with investments via managers, or else the occasional foray into the private placement market. 

There are several initiatives designed to encourage more European investors to invest directly into the real economy. In the UK for example, the Pension Infrastructure Platform (PIP) aims to make it easier for pensions to boost infrastructure investment. 

But the PIP has run into trouble with three of the 10 original anchor investors (London Pension Fund Authority, BAE Systems and BT) pulling out because the returns weren’t up to scratch while it has also faced criticism for being too slow to deploy capital. And the platform’s multi-strategy fund, which will invest in senior and mezzanine debt as well as equity, is still to get off the ground. 

Meanwhile, the EU’s €315 billion Juncker plan aims to boost investment by institutional investors into long-term investment programmes in the economic union. The details of how exactly this will work are unclear so far though. The new European Long-Term Investment Fund structure recently approved by the European Parliament could help infrastructure debt investors by creating a vehicle that allows them to lend, but there is plenty of red tape to cut through and hurdles to be jumped before investors can actually use them (such as meeting support for the ‘real economy’ requirements for investments made using the structure). 

For the most forward-looking and largest institutional investors, these government-related initiatives will always be too cumbersome and reactive to meet their needs. The authorities will design programmes to help advance their own agendas, not those of the investors. 

So institutions with the weight to go it alone should examine all parts of the credit market and find the deals that fit their requirements.  European investors looking to get the most out of the credit opportunity should look West for instructive examples of how that is done.