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Canadian Pensions Find Opportunity in Private Debt

Canadian public pension funds scooped up private debt as market upheaval from Covid-19 left borrowers willing to offer appealing terms.

Their private debt allocations ticked up more than 5% to $46.9 billion between Dec. 31 and Sept. 20, according to Preqin data. It was the biggest increase in percentage allocation in five years, from about 3% of total fund holdings to 4%.

Unlike the publicly traded bonds that have been a staple of pension fund portfolios for decades, these investments typically consist of private loans made to companies, either by a pension fund directly or through an investment manager.

“It’s been a very good year as far as deployment is concerned,” said Jérome Marquis, a managing director and head of corporate credit at Caisse de dépôt et placement du Québec, which manages $333 billion on behalf of six million workers and retirees in the province.

The increase in private debt is part of a larger push by U.S. and Canadian pension funds into privately held investments coveted for their high projected returns. But U.S. pension funds’ overall private debt holdings haven’t grown during the pandemic, Preqin found.

U.S. state and local government pension plans’ holdings fell $2.7 billion to $93.7 billion from the end of 2019 through Sept. 20, according to Preqin data, and private debt allocations stayed at about 3%. The data reflect a sampling of major pension plans surveyed by Preqin and don’t include all plans in either country.

Private debt assets lost 8.9% in the first quarter of 2020 and gained 5.7% in the second quarter, based on more than 750 funds tracked by Burgiss, a private capital data and analytics firm.

As post-financial crisis regulations have deterred banks from taking on riskier debt, pension funds have been eager to collect more interest than they can with most bonds, particularly as yields have fallen.

Over the past five months, pension funds have been making major commitments to private debt funds that managers scrambled to set up in March and April during the early days of the pandemic, said Timothy Atkinson, a consultant with Meketa Investment Group who advises pension funds on private debt investments.

“There’s been some pretty staggering numbers of dollars invested in opportunistic and distressed credit strategies over the last few months,” Mr. Atkinson said.

Caisse de dépôt et placement du Québec has more than $26 billion allocated to private debt, a roughly 15% increase from the end of last year, Mr. Marquis said. The fund in June said it would be one of four major lenders participating in a $1.9 billion loan to U.K. insurance broker the Ardonagh Group, one of CDPQ’s biggest private debt deals to date. Private debt holdings can be hard to track since many funds don’t report them as a separate asset class.

U.S. state and local government pension funds, with combined holdings of more than $4.5 trillion, control about three times as much money as Canadian ones.

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Canadian pension plans are typically better funded, have more streamlined decision-making protocols, and are often able to handle deals internally without an external manager, allowing them to react more quickly to market opportunities, said Clive Lipshitz of Tradewind Interstate Advisors, an adviser to investment managers who co-wrote a recent study from New York University’s Stern School of Business.

“They can be much more nimble,” Mr. Lipshitz said.

Canadian funds have pushed further into other private markets, with 25% of their holdings in real assets, for example, compared with 10% for their U.S. counterparts, according to the NYU study, which used 2018 data.

Some U.S. funds have added private debt investments this year.

The $405 billion California Public Employees’ Retirement System, the biggest U.S. public pension fund, found opportunities in private credit during the early days of the pandemic, interim Chief Investment Officer Dan Bienvenue said at a conference last week.

Borrowers anxious to get deals done in an uncertain environment are offering to pay 1 to 1.5 percentage points more in yield on some deals than they were before the pandemic, said Al Alaimo, senior fixed-income portfolio manager at the more-than $40 billion Arizona State Retirement System. Some are willing to enter stronger covenants, take on less leverage, and offer other terms that better protect the lender in the event of default, he said.

“We’re increasing our commitments right now to help our lenders take advantage of that opportunity,” he said.

ASRS now has $6.2 billion invested with private debt fund managers who have lent the money out, primarily to midsize companies. That’s 14.4% of the fund’s portfolio, up from about 13% a year ago, and Mr. Alaimo expects it to rise to 16% over the next two years as investment managers draw down additional dollars committed by the fund.

The higher returns can come with greater risk, however, especially as the pandemic has brought new uncertainties.

The default rate on private debt rose to 8.1% in the second quarter from 5.9% in the first quarter, according to the Proskauer Private Credit Default Index, compiled by law firm Proskauer Rose LLP to track private loans issued mainly to private-equity-backed businesses.

Ash Williams is executive director and chief investment officer of the State Board of Administration of Florida, which manages investments for the $168 billion Florida Retirement System and holds about $4.2 billion in private debt investments. He said pension funds should carefully vet private debt managers hoping to take advantage of the rising interest in the asset class.

“It sort of concerns me when I see lots and lots of people rolling out new vehicles to do the same thing,” he said.

Write to Heather Gillers at [email protected]

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