The Teachers’ Retirement System of the State of Illinois is a Springfield-based provider of retirement annuities established in 1939 to provide benefits for educators employed in public schools outside the city of Chicago. As at June 30 2013, the scheme had 160,692 active members.
PDI caught up with Scottie Bevill, the organisation’s senior investment officer – global bonds and real return, to find out more about the roots of its involvement in private debt and what kinds of strategies it is drawn to today.
Could you provide a little background to your private debt strategy – when it was launched and how it has evolved?
SB: In general, investments by TRS in private debt has its origins from the US TARP (Troubled Asset Relief Program).
TRS was part of the original investor group in the US TALF, PPIP and commercial paper programs in 2009. With the success of these programs, over time, the investment in private debt has morphed into a larger piece of the overall fixed income/income asset class.
Other private debt structures were also part of the program in 2011 and 2012 in the performing and non-performing loan space, primarily focused on real estate debt and other structured products.
Lastly, TRS began investing in senior secured direct loans in early 2013 and now has 11 direct loan platforms.
How does private debt fit into the portfolio? What useful characteristics does it provide?
SB: Private debt, now primarily in the form of senior direct loans and specific stressed – not distressed – debt, falls mostly under TRS’s special situations allocation within the overall global fixed income asset class. Although liquidity can be of some concern, TRS can invest up to 20 percent of the $8.2 billion income allocation in special situations.
Some beneficial characteristics are as follows:
An overwhelming majority of current investments in special situations are income generative, generating a much higher income stream and higher yields relative to other long-only bonds;
Most investments in special situations are floating rate, providing an additional interest rate hedge;
Strong covenant protection: staying higher in the capital structure is important to TRS staff during this credit cycle;
Strong demand for direct loans outside of the traditional banking sector due to regulations and banking capital requirements;
Above average transparency;
Solid credit analysis: the growth of private debt platforms has extracted some of the better teams and analysts from banks and other bond shops.
How do you view prospects for private debt and why?
SB: Not all private debt is the same; just like not all unitranche and mezzanine debt is the same. It is very important to be opportunistic, as well as, just like in traditional public debt, to be as diversified as possible while not over-diversifying.
Middle-market loans, not just in the US, but also in Europe, will continue to expand simply based on banking regulatory changes and the continued growth of private equity sponsors. European corporates are much more highly dependent on financing relative to US counterparts.
The mass issuance of US corporate bonds the last two to three years combined with large ECB corporate bond purchases has created an opportunity set within the lower and middle markets across various financing realms, including but not limited to bridge loans, capital relief, buyouts, term loans, project loans and refinancing.
With the growth of private debt, TRS has been introduced to the networks of insurance companies, other pension funds and sponsors who are all searching for investment opportunities falling within an acceptable risk profile and acceptable fees, in this developed market low interest rate environment.
Lastly, unlike most private equity or debt structures, most investments in special situations are shorter term in nature; three to four years relative to eight to 10 years.
You just made the recent commitments to LCM and Pemberton. Could you explain what you liked about those two managers?
SB: Though TRS has allowed or engaged in a small amount of private debt in Europe, this was our first direct private debt investments specifically for Europe.
What sort of return expectations do you have for private debt?
SB: As mentioned, not all private debt is the same. Absent externalities, there are consistent lower return expectations across most private debt structures. Within TRS’s special situations, it is more important to maintain a risk profile within the “spirit of fixed income”.
TRS staff believe carry/income will play a more important role in this era of strong central bank activity and expected higher volatility. As a result, return expectations for private debt structures are in the high single digits.