Why private debt offers chance for better returns

It is high time pension schemes considered diversifying their investment portfolios wider in the approved investment classes. PHOTO | SHUTTERSTOCK

Kenyan pension funds’ investment performance in recent times has been gloomy occasioned by poor returns from some of the traditional investment assets where their portfolios are concentrated. 

As such, it is high time pension schemes considered diversifying their investment portfolios wider in the approved investment classes.

Globally, private debt is increasingly emerging as an attractive investment opportunity for pension schemes.

Private debt typically refers to debt securities or loans issued by non-public entities such as privately held companies or special purpose vehicles (SPVs).

The issuance and trading of these debt instruments is conducted in private markets and not publicly traded.

Investment in private debt can take various forms such as direct loans, mezzanine financing, convertible debt, distressed debt, or structured debt instruments.

According to Private Debt Investor, in the US, private and public pension funds were among the top investors in private debt vehicles last year.

Global statistics from Pensions and Investments Research showed that private debt assets of the 200 largest retirement plans grew 12.5 percent to $98 billion in 2022.

For Kenyan retirement schemes, a look at this asset class can potentially enhance overall portfolio performance as well as mitigate risks of concentrated exposure in a small pool of asset classes.

First, in a growing economy like ours, private debt investments can support overall economic growth through financing small and medium-sized enterprises (SMEs).

This alignment with the Kenyan economic development goals ensures the retirement benefits sector is adding more socio-economic value in addition to the financial returns it generates.

Private debt investments often offer attractive interest rates compared to traditional fixed-income securities. The higher yields can help pension schemes generate consistent income essential for meeting the long-term obligations of paying out retirees.

Additionally, there is stability and lower volatility compared to public market investments. The longer tenures and fixed interest rates result in predictable cash flows needed to meet pension schemes’ long-term liabilities.

There is potential for customised investment structures and terms for pension schemes in private debt instruments.

Specific needs and risk preferences of the schemes can be incorporated while negotiating terms such as collateral and repayment structures, giving them added protection and alignment with the scheme’s investment objectives.

Another advantage of being able to negotiate the terms is that schemes can ask for higher claims on the assets and cash flows of the underlying borrowers.

This comes in handy in the event of default or financial distress where private debt investors typically have priority in recovering their principal and interest payments. For pension schemes, this minimizes the impact of credit events on their investment returns.

Like in any other investment class, private debt investments come with unique considerations and risks. For instance, schemes must understand that they are typically less liquid compared to publicly traded assets, and exit opportunities may be limited.

They may involve higher credit risk, as non-public entities may have a different risk profile compared to publicly traded companies.

Furthermore, valuation can be more challenging as there is no readily available market price for private debt instruments.

Pension schemes considering private debt investments should conduct thorough due diligence, evaluate the creditworthiness of the borrowers, and assess the track record and expertise of the investment managers.

Proper risk management practices, including diversification and ongoing monitoring of investments, are essential to effectively manage the risks associated with private debt.

Strategically incorporating private debt assets into their investment strategies and managing associated risks effectively can potentially enhance overall returns for pension schemes and enable them to meet their long-term obligations to their members. The shift toward this direction of private debt is worth exploring.

Josphat Muriuki is the CEO of KenGen Staff Retirement Benefit Schemes and a Financial Analyst. Email: [email protected]