When did AFA Insurance begin investing in alternatives, and what is its exposure now?
We distinguish alternatives from real estate. We have been doing real estate for a number of years and have a 16 percent allocation. We don’t see that as alternatives. Separately, we have a private equity and private debt programme. We have been doing private equity for 20 years, since 1998. Private equity now accounts for around 8 percent of assets and NAV of around $2 billion. Over the last few years the focus has been on large cap buyouts in the US and Western Europe. We began co-investing in 2007.
In 2008/09 we began making our first private debt investments. They were mostly higher risk strategies such as mezzanine and distressed debt and they resided within the private equity allocation. In 2016 we decided to give private debt a separate allocation and return requirement. We have been in a build-up phase since and private debt is now around 3 percent of total assets.
Could you describe how the private debt strategy has evolved?
Fundamentally the origin of private debt for us was the ability to put higher risk/return credit within private equity. That enabled us to do mezzanine and distressed debt. Our thinking in moving to a separate private debt allocation was to capitalise on opportunities that didn’t need a private equity return but were attractive on a risk-adjusted basis. We took a long hard look at the market and were very conscious of the low interest rate environment. My view is that certain strategies will not be viable once interest rates normalise. So we wanted something that would be viable long term and was not just driven by low interest rates.
The best opportunities were arising from bank retrenchment, especially in Europe. So we developed a focus on direct lending and unlisted/unrated private corporate credits. We believed there were strong fundamental drivers as the banks are not likely to come back, but that was overlaid with a macro view that we wanted to be prepared for a downturn so we focused on the most senior and unlevered end of the market. Our target return is 6-7 percent unlevered. We believed it offered a good illiquidity premium compared with liquid alternatives.
The build-up has been systematic. It started with Europe and then the US. In 2016 we met with 60-plus GPs and conducted a market mapping exercise to find out who was doing what and uncover their relative strengths and weaknesses. Once we’d done that in Europe, we took it upon ourselves to do it in the US. We’ve made a number of investments in Europe but we’re still implementing the strategy in the US. In the US, you have extra work to do on tax structures as a European LP.
What did you want from private debt, and from private debt managers?
We were very conscious that, as a credit investor, we wanted to limit the downside rather than maximise the upside. We wanted managers to have an origination advantage and the ability to exert control as sole lenders and be masters of their own destiny. If there was a downturn, they would be able to respond proactively. My view is that the best way to outperform is to minimise losses and you can do that by being involved in the takeover and turnaround of companies.