Nature, and in this case capital markets, abhors a vacuum. As banks and other traditional lending institutions have been forced to rationalize their balance sheets by tighter post-financial-crisis regulations, pension funds and other institutional investors have been filling the void left behind. A Fitch Ratings report issued earlier this month says pension funds are expanding their “footprint” in capital markets and are increasingly acting as guarantors, providing liquidity or future commitments and other intermediary roles.
“The cost of capital is going up for banks, primarily due to regulation, and so they have to be more careful in how they deploy their capital,” says Ian Rasmussen, senior director of Fitch’s funds and asset management rating group. “It’s a trend that certainly we expect to continue as the banks, even in a greater way, implement regulations.”
The nature of banking has changed so that even if financial institutions wanted to get back into the credit game, they would have a tough time doing so. “There are certain things banks can’t do today that they could ten years ago — and they’ll never be able to do them again,” says Ryan Bisch, the leader of Mercer’s Canadian alternatives boutique. “The holding of illiquid positions on [bank] balance sheets has changed in such a way that they are never really going to enter back into that market,” he adds.
And while institutional investors or other institutions may not enter the capital markets arena on the same scale banks had traditionally, there is potential for growth. Says Bisch: “I think there is an opportunity that exists today that didn’t exist before the financial crisis. Pension plans are certainly participating more than what they did.”
A prime example of a large pension plan providing liquidity and other investments in the capital markets is the California Public Employees’ Retirement System. In its statement of investment policy for its credit enhancement program, CalPERS allows for letters and lines of credit, which are based upon the aggregate amount of $10 billion committed. CalPERS provides direct-funded loans and will not consider transactions with municipal issuers that have declared bankruptcy in the past 15 years. The statement also says the program shall coinvest with at least one financial partner in each transaction, which shall contribute “a sizeable interest on the transaction,” although that is not specified. When asked about the program, CalPERS declined to comment.
CalPERS is certainly not the only fund interested in these opportunities. A report released by Preqin this summer called “Private Debt: The New Alternative?” shows that of 240 institutional investors surveyed, two out of three said they are considering or currently investing in private debt funds. Sixteen percent of investors have set aside a fixed allocation for debt strategies. The report mentions the San Antonio Fire and Police Pension Fund, which created a 6 percent target allocation to private debt in September 2012 and in 2014 approved a motion to search for an additional private-debt fund manager to partner with.
The trend is not limited to the U.S. In September Australia’s biggest superannuation fund — AustralianSuper — acted as one of the underwriters for the A$7.1 billion ($6.6 billion) purchase of Queensland Motorways by a Transurban Group–led consortium. The fund’s head of infrastructure, Jason Peasley, was quoted in the local media as saying it was its first foray into providing such services and something he would consider doing again on a deal-by-deal basis.
But what of the risks? Will institutional investors fall victim to the same issues that hurt banks and were the impetus behind stricter balance-sheet regulations? Fitch’s Rasmussen says in the precrisis days, capital markets debt lending and other activity was often the sole operation of a particular bank. “This is more an additive — playing at the margins, looking for opportunities — not wholesale going into some of these new financial commitments,” he says.
Mercer’s Bisch agrees and says because pension plans have long-term liability durations and the ability to invest in illiquid investments, there is a fundamental difference between what they are doing today versus what the banks did a few years ago. “That is a different risk profile than banks, where that ability to invest in illiquid investments during the financial crisis was proved to be less than what was being used at that time,” he says.
Overall, notes Rasmussen, there is an increase in analysis of pension funds and their ability to provide capital markets support. As the funds grow their programs, the ratings agencies will offer more analysis on them. In the meantime, the opportunities that still appear to be gaining speed are poised for further growth, as more institutional investors get involved.
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