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Australian Pension Funds Eye Niche Private Debt to Boost Returns

(Bloomberg) -- Australia’s pension giants are looking to expand their private credit exposure to some nascent products, as the cash-flushed industry hunts for ways to diversify portfolios and boost returns.

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AMP Ltd., one of Australia’s largest pension providers, has launched a new A$300 million ($198 million) alternative debt fund to invest in credit risk transfer, a relatively new corner of the private market. Aware Super, which manages A$175 billion of assets, is also studying the market of niche products for investment potential.

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The nation’s fast-growing A$3.7 trillion pension pool is looking for investment avenues as the sector gets more than A$2 billion of inflows each week. Many of the country’s largest pension funds such as Cbus, HostPlus and AustralianSuper have increased asset allocations to private credit. The asset class has ballooned to $1.65 trillion across North America, Europe and Asia Pacific at the end of September 2023, according to figures from investment data firm Preqin Ltd.

“Exposure to private credit is increasing across our superfund portfolios,” said Stuart Eliot, head of portfolio management at AMP. “As we already have a domestic allocation to direct lending strategies, we were looking for complementary exposures which have a different risk-return dynamic.”

AMP has allocated as much as 3% of its active portfolio to private credit. Besides credit risk transfer — a type of bond issued by banks to insure the first loss on a pool of loans — its new fund’s mandate also includes distressed credit and special situations where borrowers are in financial difficulties.

Credit risk transfer is a more familiar product to major European banks and also gaining popularity in the US. Some of the bonds pay double digit returns, attracting investors such as Blackstone Inc. and Oaktree Capital Management Ltd. AMP’s fund is offering returns between 8% and 10% over the Reserve Bank of Australia’s official cash rate of 4.35%.

Others are cautious for now. “We’re tracking that as we do with everything but we are yet to make an allocation,” said Mike Cowell, head of private credit at Aware. The fund is working out the fundamentals of the strategy behind credit risk transfer, the relative value and how it would fit within its portfolio, he said.

Australian Retirement Trust, the country’s second-largest pension with over A$280 billion of assets, has refrained from investing in such new products and is prioritizing traditional options such as corporate direct lending and asset-backed lending.

Private credit as an asset class is facing potential headwinds as heavily-indebted borrowers face high borrowing costs, tighter cash flows and rising defaults. Moody’s Ratings recently warned of more defaults in the leverage buyout sector.

A mix of strategies can help “mitigate impacts from adverse economic factors and idiosyncratic risks,” said Frithjof van Zyp, senior director at Bfinance Group Holdings Ltd. which helps investors select fund managers. “That’s where we’re having conversations particularly with the larger funds around some of the more niche areas.”

Nuveen, an investment manager for institutional clients including pension funds, said it’s exploring with some Australian pension providers niche investment strategies such as private asset-backed lending, credit tenant leases and specialized areas within energy infrastructure credit.

“For those that have done corporate direct lending, commercial real estate debt and infrastructure debt, that next iteration is an even more esoteric world,” said Andrew Kleinig, managing director and head of Australia at Nuveen.

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