Direct lending: Sovereign wealth funds

Sovereign wealth funds are not known for transparency. They prefer to operate quietly behind the scenes. But it’s not easy for them to pass without leaving ripples and the evidence shows a clear attraction to private debt and an increasing appetite for direct lending on their own account.

One of the most striking examples is Singaporean sovereign wealth fund GIC. “In the last couple of months there’s been a lot of appetite from sovereign wealth funds and I think GIC stands out,” says one market source.

Peter Atkinson joined GIC in late 2014 from Partners Group to lead a new direct lending team based in London. Over 2015, GIC deployed more than €1 billion across roughly 10 deals comprised mainly of European large-cap second-lien loans. It has been active in direct lending from its headquarters in Singapore and an office in the US for around five years but stepped up deployment in Europe since setting up in London. The investor is now eyeing smaller, more senior financings – unitranche loans above €40 million, PDI understands. GIC declined to comment.

Others operating in the space include Mubadala Development Company, Abu Dhabi Investment Authority (ADIA) and Abu Dhabi Investment Council (ADIC). All three are investment arms of the government of Abu Dhabi in the United Arab Emirates.

ADIA, which was unable to comment ahead of publication, has allocated to direct lending via GPs and a special situation bucket and is seeking returns in the midteens, a market source said.

Mubadala was in the spotlight for divesting in 2015. In September, Apollo unit MidCap Financial agreed to buy around $3.6 billion of corporate and real estate loans from a joint venture Mubadala formed with GE Capital in 2009. The sale of most of the JV assets was initiated after General Electric decided to unload the vast bulk of its GE Capital lending units. Mubadala did not respond to a request for comment.

The JV sale reflects how many SWFs rely on partnerships to access credit markets. Australia’s Future Fund upped its exposure to direct lending in Europe last year by reinforcing its relationship with London-based lender Hayfin. The Future Fund reduced its equity stake in the firm, but acquired a €705 million book of loans from the balance sheet of the lender, which Hayfin will continue to manage.

The transaction facilitated the recapitalisation of Hayfin, allowing its initial backers – TowerBrook Capital Partners and co-investors the Public Sector Pension Investment Board, the Ontario Municipal Employees Retirement System and the Future Fund – to reduce pro rata their share in the business. Hayfin’s senior management increased its stake.
The Future Fund declined to comment for this article.

Referring to the transaction in its annual report for 2014-15, it says: “The Debt and Alternatives team is highly skilled at analysing debt securities and was able to assess an appropriate value quickly. However they typically use investment managers to implement these views.”

Outlining its private lending strategy, the Future Fund says that it will continue to assess the opportunity globally including Asia-Pacific but that it will, for the majority of its strategies, access it through mandates or commingled funds.

Some private debt practitioners believe most SWFs will opt for the third-party manager approach to direct lending. SWFs move at a glacial pace, some say – a reflection of their size. Despite having oodles of cash, many are grappling with how to access the opportunity, while smaller and more nimble credit funds make hay.

GIC’s decision to deploy capital into direct lending through large-ticket mezzanine deals makes sense, say market sources, as it has more capital to deploy than most LPs, with well over $100 billion in assets, according to its website – some estimates put the figure at more than $300 billion.

An experienced private equity investor, GIC also understands mezzanine as an instrument. And more than one lender has taken their mezzanine track record and used it as a gateway to providing lower yielding but less risky senior debt. Growing origination networks is another way to access the opportunity. ADIA has expressed an interest in buying a CLO platform, while ADIC has looked at acquiring a bank that focuses on SME lending, PDI understands.

Gavin Mailer-Howat, director at advisor EPIC Private Equity, says: “Sovereign wealth funds may be well placed to take advantage of direct lending opportunities, but they first need to find smart ways of building up their own origination capability and gaining access to deals either directly or on a co-investment basis.

“This may mean teaming-up with GPs, where they not only bring additional capital but also other benefits since they are less investment constrained. [For example], they can more easily take on liquidity risk, or they may choose to make direct strategic acquisitions to fill the origination gap.”

Market access means more people and SWFs are expanding their in-house teams and partnerships to assess the opportunity. Mubadala hired a former GE Capital executive as its head of credit in 2014 and GIC plans to add more people to its London private debt team.

Last April, ADIC formed a $300 million India credit platform with Clearwater Capital and Värde Partners to invest in asset-backed credit orientated strategies, special situations lending, acquisition financing and growth funding. Temasek, a smaller Singaporean SWF, announced in July that it was partnering with Singapore-based United Overseas Bank to provide up to $500 million in venture debt to startups in China, India and South-east Asia.

Faisal Ramzen, partner at law firm Proskauer, says: “Historically, these investors were happy to be LPs or investors in someone else’s fund. But now they are moving towards becoming multi-asset managers themselves and direct lending is one of the industries they are looking into.”

In partnerships with GPs or banks, SWFs can partake in deals as and when they choose. For all their size, they do have greater flexibility than other institutional investors. Not bound by the same liability constraints of pension funds and insurance companies, they can take on more liquidity risk.

Many can afford a greater risk appetite and target higher returns over the longerterm. In 2013, GIC stated it would augment a strategy focused on long-term drivers of returns with an active portfolio of skillbased or ‘alpha’ strategies.

“For those with a primary investment orientation, [SWFs] will typically seek much higher exposure to long-term investments than to more liquid asset classes. As a result they can assume greater risk and, for example, take advantage of opportunities arising from the dislocation of financial markets, such as direct lending,” Mailer- Howat says.

SWFs are looking at direct lending in the same light as other institutional investors – a dislocation from which they can benefit. Where they differ is in their size and structure which afford them greater clout and flexibility.

Moves might be gradual and mainly through partnerships, but the future impact of SWFs into direct lending cannot be underestimated.