While private credit mandates may not be straightforward to set up, they are a reliable source of income with lower default risk, says Mark Fawcett.
Reading an article by PP's own editor-in-chief Jonathan Stapleton, Setting a benchmark for DC investment, where Jonathan reviewed NEST's decision to enter into private credit, I noticed a comment saying there's a "divide growing in defined contribution (DC) investment", that too few schemes are following in our footsteps.
While NEST is one of the first auto-enrolment schemes to get into private credit, I hope we won't be the last. Our scale has allowed us to overcome some of the cost barriers and other larger DC schemes could find themselves in a similarly strong position.
My views on this have been influenced by the eagerness of fund managers to work with NEST. Switched-on asset managers know the UK pension landscape has changed - last year in the UK we saw, for the first time, pension contributions into DC schemes outweighing those into defined benefit (DB). It felt like a watershed moment.
In 2018 I challenged fund managers to raise their game if they wanted to win business from DC schemes. I called on them to change how they considered cost, liquidity and time horizons and the result was notable - 40 fund managers submitted bids during our recent tender process, and I was impressed with the applications we received.
From this procurement Amundi, BlackRock and BNP Paribas were awarded private credit mandates by NEST. In a very competitive tender process, all three stood out for their expertise and willingness to introduce innovation.
Setting up these new mandates wasn't straightforward. It involved creating bespoke contracts and working through the detail until we got the right dynamic and felt comfortable with how money will be deployed into these assets. It took a lot of time and effort, and the three fund managers had to rethink their approach to private credit funds to ensure we were happy with the structure.
Amundi, BlackRock and BNP Paribas were all willing and able to find the solutions, which tells me there is a clear shift in mentality compared to a few years ago. DC schemes should now be able to have conversations with fund managers and consider opportunities in private credit bonds.
It's important DC schemes explore their options in private credit because there's a reason why it's a mainstay in the portfolios of DB schemes and in big DC schemes abroad. These loans are a reliable source of income at often a lower level of default risk than their public market equivalents.
Private credit loans are often insulated from the impact of the public market. We've had the benefit of being in an extended credit cycle for the past few years but this looks likely to end, and schemes must seek out alternative routes to access the returns they want at appropriate levels of risk.
NEST's move into private credit hasn't been without criticism. Particularly on our infrastructure credit mandate, we've been challenged by some in the industry that there is too much money out there chasing too few opportunities, and that we'll end up overpaying.
This shows a misunderstanding of the particular characteristics of DC schemes. We won't be competing for the loans that DB schemes and insurance companies want. NEST can afford to take more credit and construction risk based on the length of time we can invest for, giving us an advantage over other funds.
Our fund managers will be helping us find loans which offer value for money so we won't be forcing capital into the market. The risks associated with private credit can be managed.
In the coming years I hope more schemes will have the ability to seize the illiquid investment opportunity. I'm delighted it's something we can offer NEST members to help them achieve the right risk-adjusted returns for their pensions.
Mark Fawcett is chief investment officer of NEST
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