Wisconsin puts distressed debt back on the menu

The State of Wisconsin Retirement Board (WRS) is looking to position itself for the next downturn by seeking funds that utilise restructuring or debt-for-control strategies.

With more than $109 billion in assets under management, the State of Wisconsin Investment Board manages the portfolio for WRS, and is “opportunistically committing to funds targeting restructuring/debt for control strategies that are well positioned for the next market downturn”, it revealed in its June meeting materials.

Since the current recovery began, Wisconsin has demonstrated a long history of investing in distressed debt managers. Between 2009 and 2016, SWIB committed to 37 debt funds: 52 percent focused on distressed debt, 36 percent on subordinated and mezzanine funds, six percent in senior debt funds and six percent in “other” category funds.

More recently, Wisconsin invested in four distressed funds, four subordinated and mezzanine funds and one senior debt fund in 2015-16. During this time, distressed funds received 50 percent of all commitments, or $351 million: Lone Star Funds’ Lone Star Real Estate Fund V ($150 million), Centerbridge Partners’ Centerbridge Special Credit Partners III ($30 million), Apollo Global Management’s Apollo European Principal Finance Fund III ($50 million), and Lone Star Funds’ Lone Star Real Estate Fund IV (121.3 million).

SWIB allocates 11 percent of its current portfolio to alternatives while targeting 12 percent in its allocation plan. The pension fund maintains over 150 relationships tied to its private equity and debt portfolio.

The pension fund’s Core Trust Fund held $8.4 billion in private equity and private debt investments, or 8.5 percent of the portfolio in the first quarter, which is on target to meet the portfolio’s allocation policy. This portfolio generated one- and five-year returns of 16.14 percent and 13.03 percent, respectively.

Seeking to position itself for the downturn, SWIB cited several factors to confirm the looming end of the credit cycle. LBO purchase price multiples traded at 10.2x EBITDA in Q1 2018, which is higher than levels last seen in 2007. Covenants continue to weaken in the lower quality credits, while those in “higher grade private debt are still holding up fine”. The pension fund also cited investor worries around wage inflation, commodity prices, declining earnings guidance in Europe and global tariff battles.

SWIB disclosed in its June meeting packet that it is “waiting until later this year to begin preparing to capitalise on the credit/distressed cycle”.

Globally, more capital went into distressed debt in 2017 than into senior debt strategies: $60.9 billion and $60.1 billion, respectively. Even so, senior fund closings outnumbered distressed fund closings, 57 versus 28 funds, respectively, implying larger commitment sizes for the distressed strategy.

WRS is the ninth-largest public pension fund in the US and the 25^th-largest pension fund in the world, according to SWIB’s website. Participants include current and former employees of Wisconsin’s state agencies and most local governments other than the City of Milwaukee and Milwaukee County.