Alternative Financing: Making a private judgement call
Can Nordic pension funds use their experience with private equity to build private debt portfolios? Carlo Svaluto Moreolo reports
At a glance
• Nordic pension funds have built internal capacity to manage lucrative private equity investments.
• Many funds are considering or implementing private debt allocations.
• The approach to the two markets is similar but private debt capabilities might have to be developed from scratch.
Nordic pension funds are amongst the keenest investors in alternatives. In recent years, their focus has turned towards real assets. Having built sizeable private equity and infrastructure portfolios, they are using their experience to develop private debt strategies.
Members of the institutional investment community are observing the trend. François Xavier Douin, managing director in JP Morgan Asset Management’s Nordics institutional business, says: “On a pan-Nordic basis, the most important investment trend we’ve observed has been an embrace of private credit allocations. The theme is still in its infancy and it may take a number of years for Nordic institutional investors to reach their target allocations to private credit.
“Virtually all of the Nordics investors to whom we speak are either intending to increase their existing allocation to private credit or are intending to build new allocations. So this is a complex, multi-year trend.”
These credit allocations can take many forms, including senior secured, mezzanine, real estate, infrastructure and asset-backed securities. Allocations can be varied in terms of geography and market capitalisation.
The way Nordic pension funds have built previous alternative portfolios may offer clues as to how they will approach the private debt sector. Many funds in the region have run private equity programmes for years, some starting as far back as the 1990s. Over time, they have built strong internal teams.
The Danish labour-market pension provider PKA is considering a private debt allocation. Claus Jørgensen, PKA’s deputy executive director with responsibility for equity and alternative investments, says: “We are thinking about how we should do this in the best and most cost-efficient way. We would need to build internal capacity. It is not easy to just pick up exposure in this market.” He confirms that this is an area of growing interest among Danish pension funds.
PKA has significant expertise in real assets. The DKK250bn (€33.6bn) fund invests 7% in private equity funds plus another 3% in infrastructure funds. Private equity has been a strategic investment since the 1990s and five years ago, PKA set up a separate company, PKA AIP, which is dedicated to investing in private assets.
Within PKA AIP, seven people are focused on selecting private equity and infrastructure funds and doing co-investments. A further five work on direct infrastructure investments. Jørgensen says: “It’s a very complex asset class and it takes a lot of resources to be able to find the right funds and the correct co-investments, in order to reduce the costs. We think it does not make sense to invest in private equity if you cannot select the best funds. That is why we set up a team that is fully dedicated to that.”
Through this vehicle, PKA invests globally in private equity and has made investments in emerging markets, but the focus is on US and Europe. At the moment, the fund has relationships with 50 private equity and infrastructure managers and has 15 co-investments. “But, we do have a strategy to bring that number down. We want to have fewer and stronger relationships”, says Jørgensen.
Industriens Pension, the DKK142bn pension scheme for Denmark’s industrial workers, has 10% of the assets invested in private equity and 1% in private debt. Jan Østergaard, head of private investments at the fund, says the allocation to private equity is above the strategic target at the moment, owing to its good performance. The private debt allocation is below but Østergaard says this is expected to grow up to 4% in the near future. The scheme also invests 7.5% in unlisted infrastructure.
They developed a private equity portfolio in the early 2000s, whereas the private debt portfolio originates from 2013. However, the reasons for investing are similar, says Østergaard. By investing in the illiquidity premium, the scheme hopes to increase expected return versus the total portfolio risk. The return targets set are 10% for private equity and 5% for private debt.
Industriens invests in both asset classes through external managers. The private equity portfolio is global and includes an allocation to emerging markets. It consists of buy-out and venture capital funds. The private debt portfolio is currently invested in corporate loans. Østergaard adds that the investments are meant to comply with Industriens’ ESG targets.
As far as the challenges of investing in these asset classes, Østergaard explains: “You need resources to identify and source investments, to conduct due diligence and to monitor investments. Accessing the market may be challenging, particularly for newcomers in private equity. It is labour intensive to invest in these asset classes compared to listed investments. At Industriens, we have a team of 10 people dedicated to private investments.”
Among the investors profiting from an allocation to real assets is Danica Pension, Denmark’s second-biggest commercial pension provider and a subsidiary of Danske Bank. During the first nine months of 2016, Danica’s direct investments in Nordic companies returned over 15%. The company invested almost DKK2bn directly in regional corporates and made further commitments to private equity funds. Alternative investments account for 14% of the total portfolio backing unit-linked products, and a further 7% is invested in real estate.
Danica’s focus on local companies is significant. Douin says larger Nordic institutional investors have expressed a preference for direct lending to their immediate economy. “This is driven not only by a degree of comfort with credit risk given familiarity with local companies, but also by a desire to contribute funding to the local economy”, he adds.
The unanswered question is whether Nordic pension funds will use their competitive advantages to spearhead the development of a European non-bank lending sector. To many, the growth of non-bank lending is key and will determine the continued success of the European economy.
A private debt report published this year by Preqin, said: “Due to structural shifts in regulation and retrenchment from banks, alternative financing is growing at a fast pace.” According to the report, 2015 was a record-breaking year for private debt in Europe, with 35% of fundraising in the year credited to funds that target European corporates.
Preqin says the UK remains the largest European market, followed by France. However, Nordic pension funds are poised to take advantage as banks retreat from lending to small and medium sized companies.
This will take time and effort. Investors may approach private equity and private debt in a similar way, by building internal capacity for manager selection and monitoring. But they are different sectors, and this is already evident in investors’ preferences, according to Douin.
He adds: “Interestingly, Nordic investors are choosing to access private credit differently than they have historically accessed private equity. Investors allocating to private equity might once have dipped in their toes with an initial investment in a private equity fund-of-funds. Only then would they have gradually increased their participation in direct fund investment and latterly co-investing. But with private credit we are seeing a preference for more concentrated allocations to high conviction managers. Investors are pursuing strategic partnerships with specialist players to achieve their private credit allocation.”