The finest slice

The San Diego City Employees’ Retirement System’s decision to create an opportunistic credit allocation is indicative of improving awareness of the asset class.

One of the more salient questions Private Debt Investor asks fund managers is how institutional investors choose to allocate to their debt strategies. Is the traditional long-term lock-up of assets a better fit alongside private equity vehicles? Or does its return profile align with that of a fixed income allocation?

Of course, neither is completely adequate. Private debt vehicles (usually) generate stronger returns than fixed income, yet grouping investment vehicles that target low-to-mid-teen IRRs with high flying buyout funds seems untenable in the long run. Truth be told, such a concern ranks low on the totem pole for many private debt managers (who aren’t so much concerned with where an allocation would come from, as to securing one in the first place).

Perhaps the question is better suited for limited partners. The San Diego City Employees’ Retirement System (SDCERS) composed an elegant solution to the riddle earlier this month when it decided to create a 2 percent credit opportunities allocation through its “Opportunity Fund”.

The $5.3 billion retirement system formed its Opportunity Fund in 2010, targeting an 8 percent return for the strategy. The Opportunity Fund allocation is unique in that it remains blissfully undefined; dedicated entirely to strategies that fail to meet the full definitions of other asset classes.

Last year, the retirement system used the Fund to create a 2 to 3 percent sub-allocation to opportunistic real estate. That allocation was eventually put to work with a $50 million commitment to Torchlight Debt Opportunity Fund IV, which invests in mezzanine and distressed debt opportunities in the US real estate market.

“We just think this is a really compelling opportunity right now,” SDCERS chief investment officer Liza Crisafi told Private Debt Investor, adding that opportunistic credit strategies are minimally correlated to many of SDCERS other holdings. She also said that the retirement system will likely pursue the new strategy through the formation of a separately managed account, which could allow the allocation to grow over time.

Private debt has existed as a distinct asset class in the US for some time. Unfortunately, it hasn’t been until recently that limited partners – particularly public pensions – shifted their asset allocation strategies to accommodate its unique structures and return profiles. Some investors, namely massive public pensions such as The California Public Employees’ Retirement System and The New Jersey Division of Investment, have accessed the strategy through separate accounts with large firms like GSO.

The formation of a separate credit strategy by a smaller institutional investor, such as SDCERS, reveals a growing appetite for the asset class. More importantly, San Diego’s decision to lock down a separate account for its allocation is indicative of greater sophistication within the LP universe. 

As more public pensions follow the leads of CalPERS, New Jersey and SDCERS, the question as to how investors allocate to private debt will become moot. It would certainly be a welcome development.