In these times of high anxiety amid the continuing coronavirus pandemic, everyone needs something to make them smile. In the case of Ian McKnight, chief investment officer at the Royal Mail, it’s the pin he recently received in acknowledgement of a decade of service with the pension plan of the UK postal service and courier company.

McKnight, who had spells at consultants Willis Towers Watson, LCP and KPMG, as well as investment bank Morgan Stanley, ended up taking the reins at Royal Mail just after the global financial crisis. Having overseen benign conditions for most of the past 10 years, McKnight was not among those surprised that a new crisis came along eventually. “You never know what’s going to tank the market, but we’ve been worried something would disrupt it for the last 18 months,” he says.

“We’re 3.7 percent above where we’d be if we’d put this into a more liquid strategy with a similar kind of credit risk”

Bev Durston, Edgehaven

McKnight is not making any hasty moves in response to the covid-19 outbreak. He simply says: “We are watching carefully how the market develops over the coming weeks, and how managers behave around this time will lay down a marker for investors looking at them in future.”

Sitting next to McKnight (the interview was conducted just before social distancing was introduced) is Bev Durston, managing director at Edgehaven, the institutional advisory business she founded in 2013. McKnight says Durston is effectively – although not officially – the pension’s head of alternatives. While Durston visits London regularly – or did prior to the pandemic – Edgehaven colleague Bill Burstow spends three days a week in London working from Royal Mail’s offices with its existing managers.

Reflecting on how Royal Mail had been selecting its alternatives managers prior to the coronavirus outbreak, Durston says: “We have been more cautious in the types of managers that we go with and highly selective in the funds that we think are interesting. We’ve moved in certain areas from equity to mezzanine and from mezzanine to senior, so we’ve become more cautious in the overall level of risk we’re taking.”

But while this may have set up Royal Mail to weather whatever storms lie ahead, the fact is that conservatism is not likely to be the first word market sources reach for when asked to describe the Royal Mail approach.


Indeed, when Private Debt Investor canvassed the market for views on which limited partners had the most forward-thinking and innovative approaches – being prepared to consider strategies and geographies others probably wouldn’t – Royal Mail received a strikingly large number of mentions. “They have a strong allocation to alternatives, always looking for niche strategies and good risk/reward,” said one source.

Durston describes how this adventurousness has manifested itself: “Over the last seven years, we’ve done a variety of things. We’ve cornerstoned three funds and we’ve gone into specialist structured credit, US and European mezzanine debt, Asian private debt, an Asian fund with a mixture of public and private, Asian special situations and capital release strategies, for example.”

If there’s a stronger Asia-Pacific flavour to that than you might expect of a London-based organisation, that’s no coincidence. Durston, an Australian national, has been a bit of a globetrotter in her career. In Australia, she was deputy chief investment officer of superannuation fund Sunsuper and head of investments at SuperEd, the super fund advisory firm. She was also a senior portfolio manager at GIC in Singapore. Having also spent part of her career in the UK – where she was head of alternative assets at British Airways Pensions from 2008 to 2013 – she is now back in her native country, where Edgehaven is based. Royal Mail was the anchor client when she launched the consultancy in 2013.

“There’s going to be a lot of pitfalls coming down the line with people scrapping around trying to prop up failing businesses and I think it’s time to tread carefully”

Ian McKnight, Royal Mail

Having expertise effectively ‘planted’ in the region is a distinctive feature of Royal Mail’s alternatives programme. “It’s a complex region,” says Durston. “We’re in 12 jurisdictions, 12 legal systems. It takes you time to get from one country to another. You can’t just nip across countries like you can in Europe, it takes you 10 hours to get from one side of south-east Asia to the other. Thankfully we’ve found some really good managers which have exposure and offices across the region.”

McKnight says there has been a wariness on the part of fund managers towards China because of the licence required to operate there, and Durston acknowledges that the return needs to be higher because of the additional risk. She says the Asian special situations fund Royal Mail committed to has made an internal rate of return of around 16 percent net, whereas similar strategies in Europe have only been delivering around 8-11 percent.

Special situations and distressed, whether in Asia-Pacific or elsewhere, has been a theme Royal Mail has pursued with enthusiasm – mainly through contingent funds, where “we put a small amount of money in, on the understanding that we’re going to commit much more as and when there’s a period of distress,” according to McKnight.

“You do that with the better managers,” McKnight continues, “because we like to be on the front foot with a tailwind and get in early. When everyone else has cottoned on and think ‘now’s the time’, that’s when you get all the me-too funds launching and they don’t have the best access to deals, which is the key to it all.”

With private debt funds generally only prepared to pay fees on invested – rather than committed – capital, Durston describes contingent distressed funds as “a play on optionality”. Right now, with businesses struggling to navigate a way through the coronavirus crisis, it seems like a nice option to have.

Zero to low correlation

It’s no accident that Royal Mail has come to be associated with an open-minded approach. McKnight says the plan was always for the alternatives portfolio to be “zero to low correlation to everything else we have [in the portfolio].”

Lending credence to McKnight’s claim that “we’ve had very little go wrong”, Royal Mail says its private debt portfolio has returned 9.1 percent per annum since inception in 2013. During that time, Durston says nearly $1 billion has been committed and about $600 million invested. “The public market equivalent for this portfolio is the global high-yield debt portfolio and that’s delivered 5.4 percent, so we’re 3.7 percent above where we’d be if we’d put this into a more liquid strategy with a similar kind of credit risk.”

So, have any of the more exotic strategies failed to live up to their billing? McKnight pauses. “The only one I would flag is shipping. We had some exposure to shipping, and it did come through and make money, but it was the least successful strategy and luckily we avoided overweighting it.”

Durston adds that the strategy delivered around 5 percent, making it the only private debt strategy backed by Royal Mail not to reach its performance hurdle.

Summing up the Royal Mail approach, Durston says: “Essentially, we’re looking for smaller managers or niche, specialist ideas where other people aren’t hunting and some of the larger consultants can’t allocate as there is not the capacity for much larger AUM.”

McKnight says avoiding crowds is key. “We steered clear of mid-market US direct lending a few years ago because everybody was going into it. Trying to balance the scale necessary to cover that market properly with the need for alignment of interest is quite a juggling act.”

He points out that Royal Mail has gone into the direct market, but by dealing directly with family owners. “A lot of our European managers do corporate deals directly with families for high-teens returns where they’re acting almost as a private equity firm but instead of taking equity, they’re taking mezzanine and offering consultancy advice to the families. A lot of these firms want to move towards an exit and don’t want to give away a large slice of equity to a PE firm.”

The only way to make a success of what will become a major investment theme, McKnight suggests, is to access it at the pioneering stage where it’s just getting off the ground. “If there’s a big trend coming through and everybody’s talking about it, the odds are we probably bought it last year.”

‘Straight talking and blunt’

One consultant PDI spoke with described McKnight as “straight talking and blunt but extremely helpful. He’s far from a traditionalist in terms of approach and has some strong views on what’s wrong with the industry”.

In person, while faultlessly friendly, there are some hints that McKnight can become a little animated when reflecting on the industry’s failings. One of these is the accumulation of assets under management for the sake of it rather than for a particular rationale.

“We’ve stuck with managers which have maintained a sensible fundraise size through cycles and not increased it dramatically and we’ve avoided managers that have a fund but have also been offering large segregated accounts to people, because we often can’t tell what the total fundraise size is. Those guys are basically more about asset gathering and less about outcomes.”

As a firm that prefers to back specialists, another pet hate of McKnight’s is managers that are not close enough to the assets to really have a deep understanding of what they’re exposed to. “There’s a classic example of this in the liquid world where people were trading CLO [collateralised loan obligation] tranches without any understanding of the underlying assets. They were just technical traders watching a screen and that’s deeply concerning. You had a great number of market participants who didn’t understand what they were buying.”

This kind of disconnect between managers of money and the assets they were investing in was of course a characteristic of the global financial crisis. As with the GFC, the covid-19 crisis will invite close scrutiny of manager and investor behaviour in times of stress.

“There’s going to be a lot of pitfalls coming down the line with people scrapping around trying to prop up failing businesses and I think it’s time to tread carefully,” notes McKnight.

Praying for returns from speciality finance

The Church Commissioners must find a way of reconciling strong return targets with social impact. Texan Roy Kuo is into his second five-year plan at the organisation

“A bright guy, quietly spoken,” says a UK-based alternative assets consultant, referring to Roy Kuo, head of alternatives at the Church Commissioners, which has an £8.3 billion (€9.9 billion; $10.7 billion) investment fund supporting the work of the Church of England.

It may be hard to imagine a shy and retiring Texan but Kuo, an Oxford graduate, former management consultant and Muslim by faith, is arguably good at defying expectations. A certain reticence should not be confused with lack of ambition. Having been recruited to Church Commissioners seven years ago by a headhunter, he has overseen a radical shake-up of the private debt portfolio.

“When I joined, I asked them what they wanted, and they said ‘you tell us’. It was a pretty wide remit, which was fine because I enjoy solving problems. I set out the first five year-plan and we’re now into the second one,” says Kuo.

He recalls that, by the standards of UK investors, Church Commissioners was a fairly early player in private debt when he joined around seven years ago. The allocation was initially based around sponsor-backed direct lending – a strategy that could only deliver the organisation’s minimum 10 percent return expectation through a turn of leverage.

The shift to special sits

By 2015-16, says Kuo, the allocation to private debt was beginning to move “dramatically to special situations-type lending” and away from plain vanilla direct lending. With direct lending and distressed real assets investments now largely in run off, Kuo has steered Church Commissioners towards a range of speciality strategies including life sciences, technology, telecoms, real estate development, near-prime consumer finance, aviation, shipping and housing.

“We look for areas that are less well understood and where it helps with our ESG [environmental, social and governance] focus,” says Kuo. “We have mandates in areas such as sub-Saharan Africa and music royalties which are under-served and where we can add a lot of value and influence their evolution. The key issue for us is achieving our returns while also having the influence to drive things such as improvements to ESG. We always request a seat on advisory boards.”

While investments are predominantly in the US and Europe, there has also been a shift towards other geographies with meaningful exposures in sub-Saharan Africa and Brazil – and with plans to have a greater exposure to Australia going forward.

One topic that’s especially close to the heart of Church Commissioners is ESG. As one market source noted: “As a Christian group, they wouldn’t want to invest immorally; and they certainly wouldn’t want to be publicised as doing so. So, they will have been focused on these matters for a bit longer than some other more ‘mainstream’ investors.”

Kuo says the Commissioners have “the most stringent ESG policy I have ever encountered” and staying true to it was part of the challenge he was keen to take on when he first joined. “At its most basic, there are certain sectors we would avoid such as tobacco and high interest rate lending,” says Kuo.

“But there is also some nuance. We have avoided consumer finance as it’s fraught with ethical challenges. But we have sometimes done it, for example lending to people who were prime borrowers before the crisis but are no longer considered prime due to tougher credit qualifications, such as for the self-employed. We debated it and decided our involvement made sense to reduce the cost of borrowing for these people.”

Kuo is also trying to push into impact investing but “it’s difficult for us under our charter to satisfy the twin requirements of making a social impact and generating a commercial level of return”.