Higher interest rates and geopolitical risks have led some leading institutional investors put a greater focus on private debt and real assets
Alastair O’Dell
The post-Covid surge in interest rates led many institutional investors to increase their relative exposure to private debt and real assets over private equity – and heightened geopolitical risks have since compounded the dynamic.
Richard Moon, head of private markets, Railpen, said: “Given where we are in today’s environment, private debt looks relatively attractive compared to private equity.”
While Railpen’s private markets pool remains concentrated in private equity, the shifting market dynamics have led to a change in its strategy.
“On the debt side, returns have moved from mid-to-high single digit to low double digit returns. Therefore, on a relative basis, debt has become a much more important part of the way we are thinking about allocating within private markets.”
Because of these higher returns, “large swathes” of the private debt opportunity set now hit its return objective of the overall pool, according to Moon. “Are there enough parts of this universe that give us a CPI + 6% return? The answer today is yes, there’s enough.”
Geopolitics used to be actively discussed for emerging markets investments, but it is now a critical input for all private markets investments
CECILE RETAUREAU, PHOENIX GROUP
Railpen had been through a long period of relatively low private debt allocations. “Today, we’ve shifted that, in a measured way, putting money into private debt in a way we haven’t done in at least the past decade,” said Moon.
“It’s become more difficult to believe we’re going to get the 20% return on [private equity] deals today that we’ve seen historically.”
Railpen has historically produced double-digit returns from its private markets portfolio, according to Moon. “But going forward, there are quite a lot of impediments. It’s certainly not going to be as straightforward with rates where they are, geopolitical risks and various other macro considerations.
“It’s going to be a tough environment to deploy capital in private equity until the dry powder in the market works its way through valuation expectations. From a valuation perspective, it’s not looking that attractive, frankly, at the moment.”
Geopolitical considerations
LGPS investment pool London CIV has recently expanded the scope of its private debt investments and is also exploring a private equity launch.
Vanessa Shia, head of private markets, said: “Historically, a lot of our partner funds have favoured mid-market direct lending over other areas of credit. But for our next vintage we wanted to create a more diversified credit offering.
“After much discussion, we expanded our private debt fund mandate to go across into asset-based lending and asset-backed finance, which a lot of our partner funds saw as very complementary to their existing private credit exposure.”
“The current macro and geopolitical environments are certainly creating a lot of uncertainty and volatility in the market. But we look at allocations for the long term – what we invest in should be very much aligned to long term structural trends across the market.”
London CIV is focused on delivering real world impact, continuing its investments across core themes such as decarbonisation, decentralisation, demographic change and deglobalisation.
Cecile Retaureau, head of private markets at the Phoenix Group, has seen an acceleration of the bulk purchase annuity (BPA) activity in the UK in the past years. “We currently have close to £15 billion invested in investment grade private debt backing our annuity business,” she said.
“We have been ramping-up our private markets platform to be ready to go from deploying £2-3 billion per annum to deploying £4-5 billion in MA eligible private debt in the next five years. With such acceleration, we remain cautious in our investment strategy and continue to build diversification – in assets, geographies and sectors – without adding risk. This can be challenging, especially so in the unstable macro and geopolitical environment we are in today.”
For its shareholder asset portfolio, Phoenix has been investing in investment grade private credit, real assets and increasingly structured credit, and has been diversifying geographically and into new assets such as credit tenant leases, long income, insured credit, and securitisations.
“Private credit transactions, such as US PPs, still represent a large volume of what we deploy annually because they bring diversification, are relatively standardised and fast to execute,” said Retaureau.
“This year, however, has been slightly different given the macroeconomic backdrop, and we have executed more opportunities in real assets, including commercial real estate lending as well as infrastructure debt, dominating this quarter.”
With regards to real assets, Phoenix has built on its core investments in social and affordable housing, healthcare, and transports to increasingly gain exposure to core+ secular trends such as energy transition, energy security and digitalisation. “Areas where we see an attractive risk-return profile while providing stable long-term cash flows and a defensive positioning,” she said.
“Years ago, geopolitics used to be actively discussed for emerging markets investments, but it is now a critical input for all private markets investments. On top of the macro news, from elections in the US or Germany to tariffs implementation in the UK in the last weeks, it has increasingly impacted the way we assess our strategic asset allocation.”