Attracted by the prospect of higher yields than are available from traditional fixed income markets, large US public sector pension funds are increasing their investment allocations to private credit, according to a report from global rating agency KBRA.
The private credit asset class is made up largely of managed credit funds, collateralized loan obligations (CLO), and business development companies (BDC). KBRA produces ratings in each of these areas. KBRA, which described private credit as a growing asset class within the larger arena of alternative investments, said that route offers several advantages to pension funds.
Measuring the role of private credit within public pension funds can be difficult, KBRA said, pointing to an overlapping in pension fund investments.
According to the report, private credit’s higher yields can provide longer-term benefits if the liquidity shortcomings of this asset class are prudently addressed. Pension funds need to develop and maintain expertise in this area, KBRA said. The lower liquidity of private credit needs to be factored into the allocation decisions of pension fund managers, the report said, adding that the prevalence of floating interest rates is beneficial in an escalating interest rate environment.
Traditional fixed income investments of pension funds include publicly traded US government obligations and taxable investment-grade corporate debt. Private credit offers both challenges and opportunities in terms of environmental, social, and governance (ESG) considerations, KBRA added.
While private credit can effectively target specific ESG investments, the process of obtaining broader ESG data from the smaller borrowers is still at an early stage, according to KBRA. There are also difficulties in gathering ESG data from the borrower base, the report said.
KBRA traced the growth of the private credit market to the period after the global financial crisis, when commercial banks reduced lending because of regulatory initiatives amid lower risk appetites. This is when private credit providers stepped in. Starting with a base of about $200 billion in 2007, private credit funds raised over $1 trillion through 2021, the report said.
