Australian pension funds bet on niche private debt for more profits

Australian pension funds bet on niche private debt for more profits

Australia's pension giants are looking expand its private credit exposure to some emerging productsas the cash-rich industry looks for ways to diversify portfolios and boost returns.

AMP Ltd., one of Australia's largest pension providers, has launched a new US$198 million (AUD$300 million) alternative debt fund to invest in credit risk transfer, a relatively new corner of the private market. Aware Super, which manages assets worth US$116 million (AUD$175 billion), is also studying the specialty products market for investment potential.

The country's fast-growing US$2.4 trillion (AUD$3.7 trillion) pension fund is looking for avenues for investment as the sector receives more than US$1,300 (AUD$2 billion) in inflows each week. Many of the country's largest pension funds, such as Cbus, HostPlus and AustralianSuper, have increased asset allocations to private credit. The asset class has soared to $1.65 trillion in North America, Europe and Asia Pacific by the end of September 2023, according to figures from investment data firm Preqin Ltd.

“Private credit exposure is increasing in our super fund portfolios,” said Stuart Eliot, head of portfolio management at AMP. “As we already have a national allocation to direct lending strategies, we were looking for complementary exposures that had a different risk-return dynamic.”

AMP has allocated up to 3% of its active portfolio to private credit. In addition to the transfer of credit risk (a type of bond issued by banks to insure the first loss on a pool of loans), the mandate of Its new fund also includes distressed loans and special situations in which borrowers find themselves in financial difficulty.

Credit risk transfer is a more familiar product for major European banks and is also gaining popularity in the United States. Some of the bonds pay double-digit yields, attracting investors such as Blackstone Inc. and Oaktree Capital Management Ltd. The fund AMP offers returns of between 8% and 10% above the Reserve Bank of Australia's official cash rate of 4.35%.

Others are cautious for now. “We're following that like we do everything, but we still have to make an assignment“said Mike Cowell, head of private credit at Aware. The fund is working on the fundamentals of the strategy behind credit risk transfer, relative value and how it would fit within its portfolio, he said.

Australian Retirement Trust, the country's second largest pension with more than US$185,000 (AUD$280,000) in assets, has refrained from investing in new products of this type and is prioritizing traditional options such as direct corporate loans and asset-backed loans.

Private credit as an asset class faces potential headwinds as heavily indebted borrowers face high borrowing costs, tighter cash flows and rising defaults. Moody's Ratings recently warned of more defaults in the leveraged buyout sector.

A combination of strategies can help “mitigate the impacts of adverse economic factors and idiosyncratic risks“said Frithjof van Zyp, senior director at Bfinance Group Holdings Ltd., which helps investors select fund managers.”That's where we're having conversations, particularly with the larger funds, around some of the more specific areas.“.

Nuveen, an investment manager for institutional clients including pension funds, said it is exploring niche investment strategies with some Australian pension providers, such as private asset-backed loans, tenant credit leases and specialized areas within energy infrastructure credit.

“For those who have provided direct corporate loans, commercial real estate debt and infrastructure debt, the next iteration is an even more esoteric world“said Andrew Kleinig, managing director and head of Australia at Nuveen.