Liz Cain, head of debt origination for the UK's Pension Insurance Corporation, speaks about the role of investment-grade private credit, and how the markets differ between the US and the UK.
Has investment grade private debt allocations increased for PIC in recent years as the market grew?
Certainly, I've been here for nine years and when I first joined, we were doing a few hundred million a year in private debt. Now, we're doing around two-to-three billion a year. So it's definitely been an increasingly important part of the investment universe, not just for us but for our peers as well.
What has been the growth story behind this rise? Why has these products become so popular?
There's a number of reasons. It offers cash flows that you can't source, or are difficult to source, in the public market. Whether that's longer-duration cash flows, inflation-linked cashflows, or amortising cashflows, which are transactions that pay back over time rather than a bullet repayment. They're also a nice complement to what you might source in the public credit markets. You generally get a pickup to public credit as well, so you get paid for the fact that you are investing in something that's a bit less liquid, or maybe a bit more complex than something akin to a corporate bond.
It's also a good diversifier for the portfolio. So some borrowers will only borrow through the private markets rather than the public markets. They allow you to access different types of borrowers and different sectors. And it is very relationship driven so you can work closely with borrowers to tailor things that work for them and work for you.
PIC is based in the UK, whereas around two-thirds of the market is held by the US. How do the two markets compare? Is there a difference in the composition of the sectors between the US and the UK?
We will source assets from a wide range of markets, but as our pension liabilities are in sterling, the UK market is where we would naturally invest. Anything we invest in euros or dollars, we would switch that back to sterling in order to match out liabilities.
In terms of the actual private debt market, the main thing with the US is that it's such a huge market. That means that there's a much larger volume of issuance in comparison to the sterling or, indeed, the wider European markets. There's also a wider range of borrowers.
You've said that you deal only in sterling, or you specialise in sterling. How does that affect your appetite for dollar-based transactions?
We also have appetite for dollar transactions. Because we swap it back, our appetite for dollar-based transactions will be driven by a range of things, particularly the cross-currency levels, and we'll look into how that looks once it's been swapped back in sterling. That will make the dollar more or less attractive for us, depending on where the cross-currency basis is.
It's generally acknowledged that there is more supply coming from the US. Can you tell me how that differs across individual sectors?
There's actually good supply across a range of sectors in the US. This year, in particular, it's been around utilities, corporate, some large infrastructure, and real-estate transactions. That's where there's been stronger supply, historically, than in the UK. The UK does remain our core market but we haven't seen as much supply here. Where we have seen good issuance in the UK market is around areas such as utilities, so I think they'll continue to issue, and financials.
Where are the 'weaknesses' in the UK market?
There has been a lack of issuance in the 'core' regulated UK sectors of areas like housing associations and higher education. They've typically been big issuers in the sterling market but as we've moved into this higher-rate market, we've seen little issuance in those sectors.
How does the useage of CTLs and ABSs difference between the US and UK?
CTLs are more common within the US market. You do see them outside the US and CTLs are a very established product over there. ABSs are more global. However, US ABS is very big in terms of the size of the market.
How do ABSs fit within insurers such as PIC?
Historically, only a small portion of the ABS market has been suitable for insurers in our regulatory regime, because we have this concept of needing fixed cash flow, and a lot of ABS has prepayment risk in it. This means that a lot of the ABS market hasn't been suitable as a product or an asset class because of our regulatory regime. This is changing as the regulatory regime evolves. , but I don't think it will shift things in a fundamental way in terms of overall portfolios.
When we talk about new regulation, this is obviously a reference to Solvency UK?
Yes. There are going to be some additional relaxations around investment flexibility. That will allow the investment in assets that have highly predictable cashflows, so it will still be assets that are suitable for an insurer of our nature. There's more freedom as opposed to the fixed cashflows that we currently have to adhere to. There's also more freedom around what we call 'crossover assets'. These are assets that are BBB- or high-investment grade level BB. There's some technical changes around that to make those assets more palatable. But this is more around the edges and cross-over assets are not expected to be a big part of the portfolio..
What will the impact of these be?
There will be additional flexibility. In terms of the overarching aims of delivering more UK productive investment, a lot of that will hinge on the supply side as well. Whilst there are some viable UK projects to invest in, there is definitely a shortage of supply. So the flexibility will hopefully help with the investor demand side, but it doesn't fix the supply side.
How would you even fix the supply side?
Good question. It's not something that investors can fix by themselves. It needs political support through better procurement and getting projects through planning quicker. It's a much-bigger piece involving government, regulators, local authorities, planning, and investors.
When it comes to Investment-grade Private Credit, there's two models—agented and direct. Does PIC have a preference in this regard?
We actually do both, and they have their merits. Agented tends to be large, syndicated deals with a bank arranging it. They're very quick and efficient, with about two weeks for due diligence and to make the bid. They are very well bid, though. There's more investors, so you will get a smaller allocation. But the benefit is that the deal comes ready baked. It's more efficient but with a lower certainty of outcome.
If you've got smaller club deals or sole investor deals, those are great in that you can work with the borrower on more-bespoke solutions, such as giving a lot of flexibility around things like drawdown profile, repayment profile, funding mix, timing. They tend to take longer to close but I think probably have more flexibility on both sides around the timing of the close.
Pete Carvill
