LACERS may pivot towards senior debt, CLOs

The pension plan’s fixed-income portfolio needs ‘additional return for less risk’, according to materials prepared by NEPC.

The Los Angeles City Employees Retirement System is set to consider adding private credit and collateralised loan obligation investments to its fixed-income portfolio.

The LACERS investment committee heard a recommendation at its Tuesday meeting from consultant NEPC to add senior secured debt and CLO strategies to its credit opportunities portfolio, which currently includes high yield securities, bank loans and emerging debt, during its meeting on Tuesday.

NEPC recommended increasing the overall allocation to its credit opportunities, while reducing the share allotted to core fixed-income, which includes the pension plan’s bond index exposure, meeting documents showed.

The proposed asset allocation includes increasing the credit opportunities to 10 percent of the pension fund’s portfolio from 5 percent and reducing the core fixed-income to 14 percent from 19 percent of LACERS’ investments.

LACERS declined to comment.

The pension plan’s fixed-income bucket totalled $3.52 billion as of 30 June, according to meeting documents. As shares of this total, credit opportunities amounted to $778.41 million at the end of second quarter, while core fixed-income stood at $2.74 billion. LACERS’ total portfolio was roughly $15.71 billion as of that date.

These recommendations are only a preview of what will go into an official asset and liability management report, likely to be presented to the full board by next January, Carolyn Smith, partner at NEPC, told the investment committee on Tuesday.

The shift towards senior debt and CLOs is an effort to bring the pension plan “additional return for less risk than equity”, Smith said during the presentation.

NEPC sees attractive direct lending and private credit opportunities in Europe, though “opportunities may be evolving in Asia”, meeting documents read.

“European banks continue to exit the leveraged loan market due to continuing regulatory pressures and geo-political events,” NPEC also noted in the meeting materials. “European leverage buyouts continue to use less debt than US sponsors.”

The firm also noted that the mezzanine space has become a “shrinking portion in the capital structure” with “few strong performers”. Distressed debt, meanwhile, “remains limited today” except for pockets in Asia. The consultant also found CLO spreads particularly attractive, specifically the mezzanine tranches that “may offer better risk-adjusted returns” though the “strategy remains capacity constrained”.

NEPC recommended LACERS add private debt to its portfolio as early as this May, when the board was in the process of hiring the firm as an investment consultant.