| LONDON, March 23
LONDON, March 23 Pension schemes are pouring
money into European direct lending strategies, fuelling the
growth of larger funds and the arrival of new entrants willing
to lend to leveraged European middle market companies.
Hayfin Capital Management raised more than €3.5bn for its
European direct lending strategy in February, while Park Square
Capital and Japanese bank SMBC are setting up a new €3bn direct
lending joint venture.
Alcentra, the alternative fixed income arm of BNY Mellon
Investment Management, raised €4.3bn for its European direct
lending strategy this month -- a marked increase from its first
fund close in 2014 which exceeded €1.5bn.
“I would say the difference between our first and second
fund is we’ve seen a much larger investor base from the UK and
Europe,” said Graeme Delaney-Smith, managing director and head
of European direct lending at Alcentra. “I think after having
done their work and their due diligence, they have now taken
their opportunity to invest.”
He said pension funds have been a large contributor, as well
as an uptick of interest from insurance companies.
“It’s an asset class that they didn’t really have access to
before because the banks were by and large the sole provider of
middle market lending across the European market – that has
STEPPING INTO BANKS' SHOES
Since 2007, asset managers have been stepping into banks’
shoes to lend money directly to leveraged European middle market
companies as banks retrenched or repositioned following the
A decade on, the appetite for the strategies is only
increasing among pension funds and other institutional investors
hungry for returns and wary of increasing volatility in other
Earlier this month, a Natixis Global Asset Management survey
of 500 global managers found that faced with volatility, greater
risks and still-low yields, institutional investors are
currently raising their exposure to higher-risk assets – with
44% considering increasing the use of direct lending in the next
“I would say momentum is really starting to build now,” said
Rohit Kapur, senior fixed income manager researcher at
consultancy Aon Hewitt. “A lot of pension schemes at the moment
are taking first steps in the asset class.”
He said pension schemes are interested in direct lending
because they receive an illiquidity premium over high yield
bonds or leveraged loans, and are also more comfortable with the
strategies now some managers have established a track record in
the market since it took off in earnest around 2012.
Pension funds originally invested in syndicated leveraged
loans via managed accounts, attracted to larger, more liquid and
less risky loans. However, with pressure on pricing, covenants
and documents, syndicated loans are losing some appeal in
comparison with direct lending, which offers higher returns on
covenanted loans with better documents.
This has gone a long way to counteract the illiquidity of
direct lending, which pension funds previously had an issue
with. The benefit of liquidity was also lessened in a low yield
“You don’t have liquidity in the mid-market but the biggest
problem that pensions funds have is generally deploying money
and getting any yield. How worried are they if their money is
put to work but locked in, if they are generating a 5%-7%
return?” a senior direct lender said.
Hayfin managing director Glenn Clarke added: “Investors in
direct lending strategies are compensated for the illiquidity on
the basis that both the arranging fees and coupon are typically
higher than those of syndicated loans. Furthermore, middle
market credit exposure is a diversifier to typical syndicated
Pension funds also face a wider choice as the direct lending
market matures, ranging from senior debt options which pay
around 5%-7%, to higher-yielding unitranches that can pay into
the high teens, depending on risk appetite.
“There is definitely increased demand but on the flip side
we are seeing increased supply -- so new managers or existing
managers are raising larger funds than before,” Kapur said.
As the market develops, Kapur said he also expects to see
managers offer investors more liquid hybrid funds.
“One development you’ll start to see more of over the next
couple of years is managers coming out with hybrid products that
are a combination of more liquid leveraged loans and middle
market loans you typically see in direct lending.”
Pension funds have generally been de-risking their
portfolios since the financial crisis, moving out of equities
and into assets that better match their liabilities.
To invest in direct lending, they have been re-allocating
away from lower-yielding fixed income assets or moving further
out of equities.
“What we have tended to see clients do is reduce allocations
to investment-grade and equities to make a risk neutral move
into alternative credit more broadly, including direct lending,”
said Gregg Disdale head of illiquid credit at consultancy Willis
The senior direct lender added: “Credit is safer than the
rollercoaster ride of the equity markets and in the end, pension
funds will most probably get the same returns. The returns from
direct lending are basically just as good as equity.”
Pension schemes have been carving out an allocation of
5%-10% of their entire portfolio to private debt, including
direct lending, real estate debt and infrastructure debt, said
Sanjay Mistry, director of private debt at rival consultancy
This sits between their fixed income and alternative asset
allocations, he said, rather than falling into one or the other.
Funds are also starting to invest across different managers to
diversify their portfolios.
Direct lending funds may include around 20 names compared
with more than 150 in a leveraged loan portfolio – which
heightens the risk that if one deal goes awry it will affect the
(Editing by Christopher Mangham)