German institutional investors plan to increase their exposure to alternative credit, with infrastructure debt in particular, according to the Investors Survey 2023 by Bundesverband Alternative Investments (BAI), the German alternative investments association.
Alternative credit is expected to record the largest increase among alternative investments, and the share of corporate private debt and real estate debt investments in institutional investors’ portfolios will also likely rise, it added.
“We are again seeing healthy demand for infrastructure debt and corporate private debt [investments]. The real estate market is currently rather difficult and investors are cautious when it comes to new commitments,” BAI’s head of alternative markets Philipp Bunnenberg told IPE.
Investors are increasingly diversifying their portfolios through real estate debt but, overall, BAI is observing more funds’ outflows than inflows in real estate. Existing investors in real estate debt are planning either to cut their allocation or maintain their existing investments unchanged.
Significant inflows are expected for private equity, private debt, and infrastructure equity and debt, instead.
German institutional investors believe that the environment to allocate to corporate private debt and infrastructure equity is optimal, and positive for private equity, while the attitude towards real estate equity is negative, it added.
“Investors are either looking for [a level of] certainty and are now entering the liquid market, or are choosing the private debt yield pick-up through illiquidity and complexity premiums – 400-500bp currently,” Bunnenberg explained.
The demand for private debt investments, also from pension funds, fell sharply last year, but is now slowly coming back, with denominator effects declining and the stress in portfolios fading, he added.
BAI sees investors moving from private equity to private debt as the return gap has significantly reduced.
“Away from the large direct lending market, alternatives such as NAV lending or asset-based lending are becoming more important. This creates opportunities for co-investments for investors with very large NAV loans that cannot be managed by individual GPs,” he said.
The same applies to the secondary market, which continues to improve, so that 1-2% of the total market volume now ends up in the secondary market, still much smaller and more inefficient compared to private equity, Bunnenberg said.
According to the BAI survey, 46% of investors want to increase their alternatives allocation, and only 9% want to reduce it. Corporates, and especially pension funds for professionals (Versorgungswerke) already manage, or are aiming for an alternative investment quota of over 50%.
German investors, however, continue to allocate mostly to infrastructure projects abroad, citing an over-regulated domestic environment, lack of access to local projects, and thresholds for investments as main challenges for German investments, according to BAI.
Key drivers for alternative investment include portfolio diversification, positive risk-return ratio, and illiquidity premia, while ESG goals are not essential to investing in alternatives, according to the survey.
Only a minority (5%) of institutional investors plan significant changes in terms of manager selection, 19% plan to revise their strategic asset allocation, and 26% are working on tactical asset allocation changes.
Investors look mainly at track records, reputation, and a degree of specialisation when picking managers, while ESG continues to gain ground.
The demand of LPs for secondary and co-investment funds has increased lately, but the demand might have been overestimated by GPs, data shows particularly with regard to secondary funds, BAI said in the survey.
“Smaller managers sometimes have problems with their fundraising [and] an allocation is usually made to the larger managers, and accordingly the concentration in the market continues to increase,” Bunnenberg said.