On paper illiquid credit is a great idea for institutional investors, offering a steady stream of long-term inflation-linked cashflows to match liabilities and a nice illiquidity premium to boot.
With gilts still yielding next to nothing and looking expensive as a result, we at PI hear that an increasing number of investors are diversifying their fixed income exposure by turning to ‘gilt proxy’ portfolios investing in alternative, illiquid forms of credit.
Such illiquid credit has been in abundance in recent years; senior secured loans, long-lease property, private lending and infrastructure debt, to name a few, have cropped up as the post-crisis clampdown by the regulators has led banks to retrench their lending practices and no longer hold long duration assets on their balance sheets.
One asset management firm said recently that assets under management in its senior bank loan strategies increased by 46% over the year to February 2014 – from $13bn to $19bn. Elsewhere, infrastructure debt has been a buzzword among institutional investors for some time and in fact a major asset manager launched such a fund just this week, saying it already has commitments from a number of investors including Nippon Life, the Japanese insurer.
But where are the UK funds? Is there a danger too much money is chasing too few deals?
Speaking about infrastructure debt at a press briefing earlier this week, one fund manager said there had been “ a lot of money raised without there being a lot of product”, adding the scarcity of assets in this space was because banks had not yet sold them to market.
The answer for investors he said – perhaps unsurprisingly given the nature of his fund – was to diversify exposure to illiquid credit through a multi-asset approach. “If you try to buy one asset you end up being a forced buyer,” he said. “And that is what can happen with infrastructure debt.”
As with other asset classes, there could be a danger the illiquid credit market begins to look a bit frothy and enter bubble territory. Indeed, as another example one chief investment officer (CIO) I spoke to recently told me he thought insurance-linked securities were looking a bit ‘toppy’ at the moment as a lot of money has chased that.
Of course being an early mover and timing these deals right can offer an advantage. The same CIO also told me his fund got in early with a distressed opportunity arising from litigation claims and the Lehman bankruptcy shortly after the worst period of the financial crisis. He said the manager was able to make a lot of money because over the years it was one of few players that devoted resource to understanding the whole litigation claims process.
Being an early mover is the privilege of the few however, and investors need to seek assurances about all the nuances before they commit – including how they rank in the debt structure should deals go wrong. No doubt institutional money will continue to flow into these strategies, but sadly not all schemes will have the governance budget to do the due diligence required so let’s hope they don’t blindly pile in.
Alternative credit will be the subject of portfolio institutional’s half-day conference on 15 July.
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