What are the top macroeconomic issues that are currently of concern to you as an investor in private debt?
Our overarching macroeconomic concern is any uncertainty in the regulatory environment under the new administration. As investors in private debt, our central thesis is that pools of private capital can step in to provide credit where banks and investment banks find it too expensive, such as where they have been regulated or forced out via Dodd-Frank. While we are unsure there would be a full and quick repeal of the law, we do have to think about how our regulatory capital relief trades or CLO mezzanine trades, for example, would fare in an environment where publicly traded investment banks are able to rebuild their proprietary trading desks.
How do you plan to change your exposure to the distressed debt market over the next 12 months?
Over the next 12 months, we expect to allocate close to $300 million to private debt broadly – high single digit to mid-teen target return strategies. Our new asset allocation, approved by the trustees in early 2016, increased our credit allocation from 8 percent of the portfolio to 15 percent. On $14.3 billion, that’s a billion-dollar increase. To date, we have already increased most of the more liquid or accessible strategies like bank loans, hedged credit and direct lending. For higher return, more esoteric or capacity constrained strategies above, say, 9 percent net, we need to invest close to $400 million, but will do so judiciously as opportunities arise and with a view to proper vintage year diversification.
As credit investors pursue more GP relationships in order to diversify portfolios, how have you managed your fund manager relationships?
We don’t believe the number of GP relationships or number of investment vehicles diversifies our portfolio; only underlying assets do. We have recently been making larger commitments to sector specialists, who we ask to focus on what they do well and leave the portfolio construction and beta decisions to us. Under this premise, I think the number of relationships on our roster will likely remain unchanged or go down slightly.
GPs have been extending the time between capital calls by using debt financing, what is your view on this?
First, we always view IRR, and any ways to boost IRR, sceptically. Having said that, what matters to us is the net to LP cash on cash multiple. In a game of inches, if there are economic and transparent ways to squeeze efficiencies and therefore return, then that is fine.
Where do you see the best private debt investment opportunities arising in 2017 and what do you see as the key challenges?
Opportunities abound. This year we are particularly interested in non-bank packaged or private ABS, CLO mezzanine and equity, and regulatory capital relief in its many iterations.
Private debt strategies span from fixed-income substitutes to for-control deep distress and even real estate credit. Key challenges remain understanding each strategy within the context of an ever evolving landscape, opportunities and risks created by regulatory shifts, the global reach for yield, ETF and retail fund flows, central bank and currency regimes, you name it. Lucky for me, it’ll stay interesting in 2017.