Sovereign wealth funds ramp up private debt investment

By Daniel Lanyon on Monday 12 June 2017

Alternative Lending

The non-bank lending asset class is becoming increasingly of interest for these investors.

The non-bank lending asset class is becoming increasingly of interest for these investors. 

Gargantuan sovereign wealth portfolios are increasingly turning to private debt exposure with almost two-fifths of portfolios now actively investing in the asset class due to its potential for stable risk-adjusted returns and portfolio diversification benefit. 

Low return prospects from the fixed income market and equity markets hovering around record highs have prompted non-bank lending, or Alternative Credit, to become a fast growing market among a variety of investors. But, as the 2017 Preqin Sovereign Wealth Fund Review found, the most recent type of investor to increase its interest to direct lending strategies and other forms of Alterantive Credit are sovereign wealth funds,

The report found that 39 per cent of sovereign wealth funds now invest in the asset class, an increase of five percentage points over the past 12 months. The majority of sovereign wealth funds with over $10bn in assets now allocate to the asset class, including two-thirds of those managing $250bn or more, and all of those managing $100-249bn.

The financial crisis was the major spur in the rise of the private debt market owing to stricter regulations and capital requirements, both in the US and Europe, that meant banks were forced to slash lending as they were forced to repair their balance sheets.

In the meantime, mid-market companies sought new sources of capital to finance their businesses. Institutional investors were able to step into the gap. Returns have generally outperformed traditional fixed income and equity investments.

Libyan Investment Authority is one such investor in private debt that allocates to the asset class as part of its private equity portfolio. The fund targets distressed debt and mezzanine funds in Europe, North America and MENA.

While only 17 per cent of funds with less than $1bn in AUM currently invest in the asset class, 67 per cent of the largest funds with more than $250bn are active investors.  Private debt is sought after by non-commodity-funded sovereign funds: these investors make up 43 per cent of sovereign wealth funds active in the asset class, despite comprising just 37 cent of the total sovereign wealth fund universe.  

Mezzanine investments are the private debt fund type most appealing to sovereign wealth funds, with 70 per cent targeting the strategy over the next 12 month and direct lending is sought by 53 per cent.

Sixty per cent of sovereign wealth funds will target Europe in the next 12 months, ahead of 53 per cent that will seek investments in North America.

Ryan Flanders, head of private debt products at Preqin says the uptick shows that private debt is an increasingly attractive asset class to sovereign wealth funds.

“Sovereign wealth funds comprise some of the largest investors in private capital, so their increased participation in private debt is likely to have a significant impact on the future of the asset class. Given their overall tendency to prefer longer-term, lower-risk investments, as more sovereign wealth funds become active in the space we may see a swing towards direct lending investments. At the same time, sovereign wealth funds’ ability to commit large sums of capital to vehicles may provide a further boost to future fundraising.”

Capital raised for private debt funds closed in 2016 totalled $94bn; although slightly below the total capital raised in 2015 ($98bn), fundraising had nearly quadrupled from $25bn in 2009.

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