As US investors place more money into private debt funds, a number of different approaches are emerging. Longer-tenured investors, including some pension funds, are moving to a more creative approach, such as setting up large separate accounts to get better deals on terms and fees, international investment, and more esoteric or specialised energy or real estate funds.
In the US, investment consultants have huge influence over where the capital ends up. NEPC, for instance, is recommending more Asian and European strategies to clients, while Aksia and Meketa are moving more toward distressed debt, special situations and non-performing loan investments. With the recent high-yield bond tumble, some investors have become concerned that another recession is closer than originally thought, which is prompting LPs and consultants alike to look more closely at distressed strategies.
With many big managers like Oaktree, Oak Hill Advisors and Carlyle currently in the market with distressed vehicles, those LP interests should have no problem finding what they are looking for.
Several US pension funds have launched direct lending searches in recent months. The $27 billion Iowa Public Employees Retirement System started its search for managers to handle a $200 million-$400 million direct lending mandate in September.
The pension fund was seeking US mid-market managers that invest predominantly in first lien senior debt. Consulting firm Wilshire Associates is assisting with the search. Applications were due 11 December and final manager selection is expected in March.
Two public Chicago pension funds also started searching for direct lending managers last year. The Chicago Laborers Annuity & Benefit Fund and the Chicago Policemen’s Annuity & Benefit Fund, both advised by NEPC, have posted requests for proposals (RFP). The shortlist is expected to be finalised shortly.
The $2.6 billion San Antonio Police & Fire Pension Fund, meanwhile, recently invested $35 million in funds managed by Veronis Suhler Stevenson and Pine River Capital Management as part of its new private debt allocation.
PARTY IN AUSTIN
Several of Texas’s largest state pension funds are placing big bucks with private debt managers.
Teacher Retirement System (TRS) of Texas, which has been investing in private debt funds as part of its private equity portfolio for several years, most recently committed $50 million to Stellex Capital Management, a New York- and Londonbased distressed shop that spun out from Carlyle in 2013.
The $135 billion TRS was busy with credit in 2015. It invested $400 million in energy credit funds managed by GSO and Avenue Capital Group as well as topping up its broad credit mandates with Apollo Global Management and KKR by $2 billion each, bringing them to a total of $5 billion each.
TRS has a slew of other managers in its private debt bucket, including Lone Star Funds, TPG and Colony.
Texas County & District Retirement System, also based in Austin, recently invested in the Shamrock Capital Advisors’ Entertainment IP fund at $50 million. The fund lends to entertainment and media companies.
The $25.2 billion pension fund originally established a 2 percent allocation to direct lending strategies in 2013 and hired Los Angeles-based Crescent Capital Group that year as its first lending manager. The pension fund has expanded its commitments to include distressed, special situations and other credit vehicles using both private equity and hedge fund-style vehicles.
TRS is advised by California-based consultant Cliffwater which recently established an index to track direct lending.
Another Austin-based pension fund has recently started to make big waves in the debt space. The Texas Municipal Retirement System (TMRS) established a firsttime private equity allocation at the end of 2014 and, in March, hired StepStone to advise on these investments. In the end, though, it allocated most of the private equity bucket to private debt funds.
The $24 billion pension planned to invest $300 million in PE strategies each year. In October, TMRS hired its first managers, of which $200 million went to debt strategies: $75 million to TSSP Adjacent Opportunities Partners; $65 million to Carlyle Energy Mezzanine Opportunities Fund II; and $60 million to HIG Bayside Loan Opportunity Fund IV.
This was followed by $1.75 billion committed to direct lending strategies with Golub Capital, HIG Whitehorse, TCW and White Oak Global Investors. The pension plan established a 20 percent non-core fixed-income allocation last summer and planned to use direct lending managers for part of it.
Separately managed accounts have been growing in popularity among US pension funds investing in private debt strategies. In November, the New Jersey Division of Investment (NJ DoI) placed $250 million with the Blackstone TacOpps Residential Opportunities vehicle, which was set up to acquire and manage proprietary, non-agency residential mortgage loans and mortgage services rights. New Jersey was a seeder for the vehicle — the first such fund for Blackstone — and negotiated a 1 percent management fee on invested capital, no incentive fee and a 25 percent profit participation interest.
The Garden State pension plan also invested in a large separate account with Och-Ziff Capital Management. Most of the money went toward credit and real estate strategies.
NJ DoI will pay a management fee of 75 basis points of the net asset value of the entire Och-Ziff book and a 20 percent performance fee over a 6 percent hurdle rate. Because of the size of the platform – about $1.4 billion – the division also negotiated a management fee waiver for the first year.
“The division also retains veto rights over all private transactions in the platform and has access to detailed investment memoranda and the deal teams. Frequent and candid interactions with Och-Ziff have been valuable in the management of the division’s broader portfolio,” read documents published by the investor. New Jersey, which established a 5 percent global diversified credit allocation in the summer of 2014, has been hiring debt managers via both separate accounts and commingled funds.
In a neighbouring northeastern state, Pennsylvania Public School Employees Retirement System (PSERS) has also been pouring money into private credit. The pension fund hired its first private debt portfolio manager, James Del Gaudio, in April and has been using in-house private equity and fixed-income investment staffers, as well as consultant Portfolio Advisors, to make manager recommendations. Its 2015 hires have included TPG, Avenue, Värde Partners, Blackstone Real Estate Debt Strategies, Cerberus, Sankaty and Carlyle, among others.
In December, PSERS established a $350 million separate account with Philadelphia-based LBC Credit Partners. The portfolio will invest alongside LBC’s fourth fund, which the firm is now raising, as well as future successor vehicles.
The PSERS pension fund also invested in TPG’s TAO vehicle, which has recently been a popular staple among US public funds. The open-ended fund consists of a serious of parallel vehicles that invest alongside the TPG Special Situations Partners’ platform, TPG’s $12 billion debt business. These include the distressed TPG Opportunities Partners funds, the US and European direct lending funds and various special situations vehicles.
LPs and their advisors need to do careful due diligence on managers to avoid mere trend followers. And new debt players, in turn, need to do their homework on prospective clients. Just because private debt happens to be a popular strategy at the moment, it doesn’t mean that raising money from institutions is simple.
Far from it.
Many of the firms winning mandates from these pension funds have been managing institutional capital in debt strategies for years.
Successful fundraising often takes years of courting pension funds’ investment officials and board trustees as well as getting acquainted with the consultants. Most large and mid-size pension funds employ a different advisor for a specific asset class, and some, like CalPERS, even have a pool of advisors for private equity. Many of the consultants have ‘buy lists’ of pre-approved managers that they recommend for a given strategy, such as NEPC’s Focus Placement List.
For pensions that issue formal RFPs, the application process is no easy task either. The documents are often lengthy and require reams of information. A little-little known secret is that by the time a pension fund issues an RFP, its executives often already have a good idea of whom they intend to hire.
It’s up to the managers in question to get in front of these clients and their advisors first and the effort it takes to get there can’t be overstated.
DIRECT LENDING TRACKER
The Cliffwater Direct Lending Index (CDLI) is based on underlying loan performance at public and private BDCs since 2004. Alongside the index launch, the consultant produced a research report that highlighted several of the strengths of mid-market lending. The report said direct lenders deliver a healthy 10 percent return, have shorter lockups than private equity, are not as susceptible to interest rate moves (because most of the loans are floating rate) and typically have lower credit loss rates than highyield bond funds.
The 9.92 percent return between September 2004 and September 2015 estimated by the CDLI and compared with other alternative indexes falls below only the Cambridge US Buyout index, which clocked in at 14.72 percent over the same time frame.
“Based upon these CDLI historical return and risk measurements, we view direct lending as a valuable source of high and steady returns, driven primarily from interest income, but with moderate short-term volatility that is linked to overall market risk and created by realised and unrealised credit losses,” the research piece said.