PSP credit head: ‘Enough to worry about, but market’s not doomed’

US pensions should avoid riskier debt as the private credit competition heats up and prices drop, says David Scudellari at PSP Investments.

David Scudellari, head of principal debt and credit investments at the Ottawa-based Public Sector Pension Investment Board, tells Private Debt Investor about the importance of flexibility within a private credit portfolio, how competition affects pricing and the European debt market.

There is talk about the end of the credit cycle nearing and our being in the final inning. Does that affect your strategic planning as far as private debt at this point?

DS: That is definitely something we think about carefully. In today’s market, there is very little differentiation in the pricing of risk. And in a frothy environment like that, we are avoiding the riskiest investments. The best way to protect us, or other pension plans, is to make sure that high risk allocations are underweight. And the key to outsize performance is avoiding disasters.  In addition, you have to make sure that on every deal, you do a “deep dive”, or making sure you’re not missing anything, as far as assessing the company, and making sure to talk to the right industry experts.

How worried are you by levels of competition and the effect this has on pricing?

DS: There’s enough to worry about, but the market’s not doomed. We have seen pricing coming down dramatically. Nowadays a solid  leveraged buyout transaction will cost you LIBOR plus 350 basis points, which would have been LIBOR plus 450 or plus 500 not so long ago.

Of course, the pricings vary by layer of capital. Also, this year could be the first year that the high-yield space didn’t have a disruptive an event, which it typically goes through around four weeks out of every year. So there’s always one or two things that could tip the market over. But we’ve seen this movie before. Nobody knows when, but they know how the movie will end.

How do the credit markets in Europe differ from those in North America?

DS: In Europe, private credit is definitely a different market. First lien debt is a tight market in US, but it is nothing like what is going on in Europe. Given the role we can play in acquisition financing, given our global niche and our comprehensive approach to partnerships, we can bring a fair bit to the table there, even if at the moment there is less first lien opportunities in Europe.

Are you easily able to achieve the diversification that you would like in private debt?

DS: Our business is set up to ebb and flow. So, we’re not in a box and can only do X percent of first lien or only first lien, etc. The rationale for that strategy is that over time, you don’t know where this is going to go, so you need flexibility to zig and zag.

What are the opportunities or returns you are targeting in this asset class?

DS: We have C$11 billion ($8.76 billion; €7.37 billion) to deploy. In our business plan, I want to maximize returns, but the problem is that it is hard to scale up to C$11 billion. But looking into first lien and looking into the high yield market, we pick spots where we want to play, shooting for single-to-double digit returns. However, we don’t use leverage in our portfolio, we don’t have redemption risk, and that allows us to be creative in creating solutions for a financial sponsor. About two-thirds of our portfolio is floating rate, though we do have some fixed-rate exposures.

What’s in store for PSP for the rest of this year?

DS: We’re planning to grow dramatically the next decade. Right now we have six people in London and 20 in New York and two in Montreal. Currently, I am hiring with active searches to add to the team in London and New York. 

PSP portfolio performance

The growing private debt portfolio held by PSP, which manages assets for three national Canadian pension plans, showed a 27.5 percent return for the one-year period ending 31 March.

This represents more than double its 12.4 percent target return for the asset class. The one-year period – which PSP counts as fiscal year 2017 – marks the first full fiscal year that private debt platform has been in operation, the firm’s 2017 annual report showed.

PSP boosted its private debt assets to C$4.4 billion by March, up from C$640 million a year prior. By comparison, PSP’s total assets under management reached C$135.6 billion, a 16.1 percent increase from C$116.8 billion in AUM a year earlier.