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NEPC recommends niche private debt strategies – exclusive

The US consulting firm is keen on international mid-market lending strategies and structured credit as return-enhancing portions of clients’ opportunistic allocations.

NEPC consultants are seeing opportunities in ex-US mid-market lending strategies and niche structured credit investments in an environment where outsized returns are hard to come by, the LP consultants told their clients at a conference last week. In a panel on opportunistic allocations, the topic quickly veered toward private debt strategies when a client asked where the firm is seeing more opportunities for enhanced yield these days.

The consultants recommend clients implement a 0 to 10 percent opportunistic allocation to house strategies that are lucrative at a specific time. Neil Sheth (pictured), director of alternative asset research at NEPC, pointed out that the timing to invest in liquid credit strategies versus more illiquid options can change quite quickly and LPs need to be on the ball. In 2008, around the time of the last financial crisis, liquid credit strategies were more in favour, for instance, while the following year the illiquidity premium started to emerge, where distressed, mezzanine and whole loan strategies became more attractive and NEPC was recommending more of them at the time, Sheth explained.

Sheth said investors need to proactively structure portfolios and the opportunities the firm is seeing today are ones that don’t fit neatly into other allocation buckets. Private debt especially lends itself well to a hybrid model between private equity and hedge funds, Sheth said.

The firm thinks long-term return expectations for most asset classes are quite low at the moment, with even alternatives expected to deliver high single digits. The firm estimates private debt long-term returns at 7.5 percent and private equity at about 8.5 percent. On a return table the firm presented, emerging market equities showed the most potential at 9 percent.

The consultants said mid-market debt globally looks attractive with banks pulling out of lending. The firm began recommending the strategies several years ago in the US, but is now doing increasingly more work on European and Asian lending firms. The returns there have been in the 8 to 13 percent range, which NEPC finds is a good risk/reward spectrum.

The firm has been very active on European direct lending and been happy with the returns there, Sheth said, though he reminded investors that it’s important to hedge currency risk. “We set up US dollar share classes with our clients, otherwise the return would be zero,” he said. NEPC recommends clients invest in direct lending strategies through their fixed-income allocations.

NEPC also likes structured credit strategies around CLOs and co-investment funds, particularly those that can strip out mezzanine or equity tranches, look attractive. Eagle Point Credit Company is a firm that NEPC recommends in the space, which owns a majority of the CLO equity tranche. The fund has a three-year lockup and is expected to generate 16-19 percent net IRRs.

NEPC, which held its client conference at the Hynes Convention Center in Boston last week, advises a range of US institutional investors, including public and private pension funds, foundations, endowments, healthcare organizations and family offices. The firm has about $900 billion in assets under advisement.