The times are changing in Chicago

It seems private debt is quickly becoming a darling of pension fund portfolios, judging by the chatter at this year’s Private Equity Exclusive conference. Though investors must be mindful of the risks.

 

What  a difference  a year can make.

 

When  PDI  attended Pension Bridge's  Private Equity Exclusive  conference in Chicago last year, meeting most LPs there resulted in questions such as, “Private debt? What's that?” But this year, many investors were investing in the sector, eager to learn more about it, doing searches for managers and talking about it as a legitimate asset class.

In Chicago in particular, and the broader state of Illinois, a lot of movement has been made on private debt investing, with several pension funds placing money with direct lending managers, opportunistic investments, European credit and distressed debt.

The Chicago Policemen's Annuity & Benefit Fund made  several commitments to direct lending and opportunistic credit funds recently, the Chicago Transit Authority is  doing a search  in the space, while the Chicago Teachers Pension Fund is  looking for  a real estate debt manager. And the Teacher Retirement System of the State of Illinois  recently placed  money with two European debt managers.

Managers seeking money from US public funds should note a few things. One is that  the influence of consultants  in alternative investing can't be overstated. Public pension plans are often too short-staffed to diligence alternatives properly, so they rely heavily on their consultants to do the work for them. NEPC and Verus have lately been driving a lot of visible traffic into private credit from pension funds, for instance.

Managers that are well-regarded by LP consultants can often get money flowing to them from many of the advisors' client. Others complain that, even at pension funds where they have good relationships with the investment staff or trustees, they can't get in the door if they are not on the consultants' buy lists.

They are labelled differently at the various advisory firms, but a “buy list” is an approved roster of managers in a given asset class that consultants have already done due diligence on and approved for one client. This means they can easily place another client with that manager without having to do a new search or due diligence process.

Much of the talk at the conference during many panels and side conversations was about when the credit cycle will turn. Industry experts said that while it's seven years into a recovery, we couldn't possibly be far away from another downturn.

 

And while we at  PDI  are excited that private debt is becoming a legitimate asset class, and are among those helping this process along, we'd also like to remind market participants about risks. In times of market turmoil, risky debt investments are often the first shoe to drop.

Aside from credit risk, there is also concentration risk. Given the process by which managers are placed with pension funds by consultants, there has been talk about a lot of money going to “consultant-approved” managers, which are doing a lot of risky deals at a late stage in the credit cycle. If the loans in these managers' portfolios go sour during a downturn and these GPs have tons of money from public pension funds, there will be few places to hide and the pain will be felt widely in the LP community.

While it's easy for pension funds to just rely on consultants in alternatives, it might be wise for staff and trustees to do their own due diligence some of the time. And while vetting alternative funds, especially in private credit, is a lengthy process for consultants, doing more diligence on more managers and sprinkling clients' portfolios with different firms, would be prudent on advisors' part, too.