Sovereign Wealth Funds
Experts understand that information leaks slower in private credit compared to public markets. Private credit was embraced by public institutional investors at first for moving company loans away from systemically important Wall Street banks and into specialist firms. Global asset owners such as deep-pocketed sovereign wealth funds and public pensions have disintermediated traditional lending channels over the past 20 years by embracing the private credit asset class. Wall Street and alternative giants such as Ares Management, Apollo Global Management, and Intermediate Capital Group have taken notice. The private credit market was under US$ 300 billion in 2010, but is projected to grow to US$ 3 trillion by 2028, according to SWFI research estimates. In 2023, BlackRock forecasted the private credit market to balloon to a US$ 3.5 trillion market by 2028.
An extended decade of super-low interest rates, fueled by the regulatory commandments stemming from the global financial crisis of 2008, has given light to private credit. With stricter banking regulations in both the U.S. and Europe, credit risk has accelerated from traditional banks with deposits to credit managers with limited partner interests. SIFI-banks such as UBS Group AG, RBC, and others have thrown shade at these credit products calling out a dangerous bubble, even though these mega banks were partially responsible for the 2008 GFC with their subprime mortgage products and CDO ventures. Asset owners are reminded of the trifecta: the fall of Lehman Brothers, approval of Dodd-Frank, and Basel III. Regulation has not been the only reason for the change, some European banks are being coerced from “ESG” special interest groups to not lend money to oil & gas companies, which some private credit funds see an opportunity to fill that void – money never sleeps, right?
Another driver of the growth of private credit includes the growing debt burden jolted by the sharp rise in interest rates. The other benefit for global asset owners is simple accounting. There is no secondary trading in private credit. Private credit loans trade rarely compared to bonds; thus, price valuations can appear favorable and less volatile to the limited partners. There is no mark-to-market pricing.
U.S. Public Pension Funds Investing in Private Credit Funds
| Year | Committed Capital in Billions USD |
|---|---|
| 2018 | 23.65 |
| 2019 | 21.81 |
| 2020 | 43.10 |
| 2021 | 43.52 |
| 2022 | 31.27 |
| 2023 | 24.39 |
Note: Including real estate debt funds (mortgages). Replicate this on SWFI.com: BuyerType: Public Pension, BuyerCountry: United States. Credit Fund. Real Estate Fund (Mortgage).
Global Asset Owners
Sovereign funds like Singapore’s GIC Private Limited had formed a plethora of ventures with fund managers in areas such as residential lending, aircraft leasing, and other non-bank ventures, while Abu Dhabi-based Mubadala Investment Company remains committed to utilize its sizable balance sheet to lever the deal flow of alternative managers such as Ares, Apollo, and to an extent Barings. In 2024, Mubadala committed US$ 1 billion to New York-based Blue Owl Capital’s credit platform, with an initial focus on the fund manager’s technology lending strategy. Mubadala was interested in getting deal flow to lend to high-growth software and technology businesses in the U.S. Korean pensions, insurers, and banks have longed for private credit investments overseas to increase yield. The Korean Investment Corporation (KIC) has ambitions in U.S. private credit and partially accomplished this by purchasing, a passive, non-voting, minority stake in Golub Capital. Golub Capital was founded in Manhattan in 1994 by Lawrence Golub who had worked at Allen & Company. On the public pension side, the California Public Employees’ Retirement System (CalPERS) has been seeking to augment private markets exposure, even though they keep losing CIOs – such as the September 2023 exit of Nicole Musicco. CalPERS is seeking to increase its exposure to private credit. In March 2024, the investment committee of CalPERS approved a new asset allocation, which partly enhanced its new private debt allocation 3% to 8%.
Andrew Edgell, Global Head, Credit Investments at CPP Investments. Photo credit: CPP Investments.
In an interview response dated March 2024, SWFI asked Andrew Edgell, Global Head, Credit Investments at CPP Investments about the organization’s continuance of credit fund allocation for 2024 and 2025? Edgell responded, “The short answer is yes. In the context of our total global credit portfolio, which is currently C$62 billion, we anticipate that between 15 and 20% of that would be investments with managers or other partnerships. As our portfolio grows, we expect the allocation to fund managers to also grow commensurate. So if you think that over the next five years we’re almost doubling the size of the portfolio, then the amount allocated to managers will increase significantly.”
Edgell joined CPP Investments in 2008 as one of the first members in the organization’s then nascent credit team. He is now responsible for all of CPP Investments’ public and private credit investments globally. CPP Investments joined hands with its Maple peers in this asset class. CPP Investments is no stranger to private credit and buyouts. In August 2015, the Canadian giant acquired Antares Holdings, which owns Antares Capital in a transaction that was valued at approximately US$ 12 billion, including the acquisition of certain related loans from third parties from GE Capital. In January 2023, the Alberta Investment Management Corporation (AIMCo), which oversees funds including the Alberta Heritage Fund, and the Public Sector Pension Investment Board (PSP Investments) agreed to jointly commit to invest in loan transactions sourced by PSP Investments. AIMCo began investing in private credit in 2010. PSP Investments gave life to its credit investment practice in November 2015, which was known at the time as private debt investments.
Often, these mega public asset owners will participate on both sides or part of a consortium on deals. For example, in 2021, PSP Investments and CPP Investments was part of a lending group in connection with the acquisition of cybersecurity firm McAfee Corp. The investor group for McAfee was led by Advent International, Permira Advisors, Crosspoint Capital, CPP Investments, GIC and a wholly-owned subsidiary of the Abu Dhabi Investment Authority (ADIA). Coincidently, McAfee’s founder John McAfee died in June 2021 in a Spanish prison. Even superannuation funds from Australia are on the prowl for private credit. AustralianSuper has more than US$ 4.5 billion invested in private credit globally and is has long-term plans of tripling the exposure in the coming years. In June 2022, Apollo formed an Asia-Pacific credit strategy in partnership with Hostplus. The strategy launched with US$1.25 billion in assets, following an inaugural raise that included a US$ 500 million anchor commitment from Hostplus alongside Apollo’s internal and affiliated insurance balance sheets. For superannuation funds, credit plays an important role in their strategic asset allocation in a wish to spread investment risk and smooth the ups and downs of market cycles.
Winning Strategies
SWFI asked if there are there any specific strategies that stand out – direct lending, middle-market direct lending, aircraft leasing? Is the asset owner open to new managers vs. incumbents?
Edgell replied, “globally, with increased bank regulation, we see opportunity around the asset backed finance markets, for example, in consumer-related portfolios such as residential mortgage, auto loans as well as equipment finance. Across different categories of commercial real estate, we anticipate there will be opportunities as the valuations and capital structures get sorted out. And, we expect that as the LBO market picks up, there will be more opportunities to buy primary issuance LBO paper.
In terms of the second part of the question, we’re primarily a direct investment platform, but we’re always open to partnerships in different forms and will often work with partners in unique regions or in unique asset classes that require a specialized skill set.”
CPP Investments is active in a wide range of strategies. In March 2024, CPPIB revealed a deal with Redwood Trust, Inc., a real estate investment trust. The deal included a newly formed US$ 500 million asset joint venture and a US$ 250 million corporate secured financing facility that CPP Investments is providing to Redwood. The JV will initially invest across the broad suite of Redwood’s residential investor bridge and term loans, targeting more than US$ 4 billion in total acquisitions.
Partnerships
Armed with a mission of generating risk-adjusted returns, SWFs are tasked with finding partnerships with private credit managers, banks, and other companies. SWFI asked Edgell the question – is your organization keen on partnerships with large credit or alternative managers?
Edgell answered, “we are open to partnerships and long-term arrangements with banks and other originators of global credit. This is an interesting opportunity because there is a paradigm shift happening where credit risk is shifting from bank balance sheets to private credit due to regulations requiring banks to hold more capital. Banks are exploring their role in the private credit market and some have announced partnerships with private credit institutional investors. In the meantime, the banks have continued to drive the syndicated credit markets, so issuers have options.”
Risks in Private Credit
There are valid concerns that with the global propagation of private credit vehicles, less due diligence and riskier deals can pose a dangerous threat to aggregate returns in the asset class. With a shadowy market background, higher-prolonged interest rates could exacerbate higher debt burdens and thus impact EBITDA and other cash flow measures, especially from financially-opaque entities with questionable business models. Cue hysteria. On the other hand, private markets are ripe with information asymmetry, which has advantages, but what are growing risks that asset owners should be aware of as they are pitched these strategies?
Edgell answered, “with increased flows of capital looking to invest in private credit there are risks, but these risks are balanced by a number of factors. For example, there are a lot of smaller funds or newly-formed funds that have an opportunity because banks have been moving out of the space. A lot of these managers are sophisticated investors and I think they’ll do well. But it’s no secret that a brand-new private credit fund is not going to have the same kind of risk management oversight and governance processes as a bank or an institution with a long history in private credit.
But there are some important counterpoints to that. Since the GFC, there’s been quite a bit of discipline in the corporate credit market – even in the leveraged finance market. For example, the coverage ratios, the yields to total debt that companies are being capitalized at are lower than they were then. There is also much less leverage in the system.
There are two other factors that should also be taken into account. PE firms have raised so much money and have so much dry powder, they are willing to use that dry powder to protect some of their companies. And, there are fewer maintenance covenants these days, which on one hand is a negative for creditors, although it does provide breathing room for PE firms to fund their best investments through temporary liquidity squeezes – this ends up being a positive for creditors.
When you boil it all down, you need to invest in resilient, strong businesses.
Global asset owners like CPP Investments are engaging in calculated steps with informational advantages, seeing the opportunity to fund businesses that can withstand different market-cycles. ADIA has a maximum 7% allocation to credit. SWFI estimates around US$ 50 billion could be the maximum for ADIA in this asset class. ADIA, whether through its private equity or real estate department, are spotting for openings to invest where traditional banks simply cannot. For ADIA, the sweet spots for credit are in the U.S., Western Europe, and the metropolitan areas of Australia. In 2023, ADIA doubled its investment in Qualitas Diversified Credit Investments.
A lasting takeaway for prospective managers in the credit space are finding resilient companies to lend to, knowledge sharing opportunities, lowered-fee structures, and co-investment ventures. These cash-rich public institutional investors like GIC and ADIA are happy to fund private credit venture deals and use their balance sheets, but desire to pay less in fees for putting up billions in capital in these deals. Even in Apollo’s recent 10-K released in 2024, they state, “in addition, certain institutional investors, including sovereign wealth funds and public pension funds, continue to demonstrate an increased preference for alternatives to the traditional investment fund structure, such as managed accounts, specialized funds and co-investment vehicles. Even though we have entered into such strategic arrangements, there can be no assurance that such alternatives will be as profitable to us as traditional investment fund structures.” Furthermore, some asset owners are asking for more information rights and access to industry intelligence. Funds managers like Apollo are happy to comply, as they get admission to a large funding source for both their traditional private market fund products and side arsenal to take down more-capital rich deals to spread risk. Private credit remains an asset class that will continue to grow, despite headwinds in 2024.
Keywords: California Public Employees Retirement System, Canada Pension Plan Investment Board
