Appetite for Private Debt?

Private debt touted as a de-risking alternative to annuities.

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rock arch unstableAs pension plans move into better solvency positions this year, should they be lowering their risks by purchasing an annuity or looking at investment strategies to manage them in-house?

From a private debt perspective, it’s possible for a plan to structure investments to mirror the de-risking benefits of buying an annuity from an insurance company, said Louis Bélanger, vice-president and director at TD Asset Management Inc., during a presentation on private debt and liability-driven investing hosted by the firm in Toronto on Wednesday.

Insurance companies face significant regulations and thus have minimal appetite for short-term volatility, noted Bélanger. “As a result, they are going to adopt very conservative investment strategies, which pretty much forces them to be in 100 per cent investment-grade fixed income.”

On the other hand, pension plans may find holding a large allocation of private debt risky, said Bélanger. “But in fact, the [Canadian Institute of Actuaries] considers private debt to be less risky than corporate bonds,” he added, noting the benefits of comprehensive covenant packages that provide early warning signals if something goes wrong.

Bélanger also noted that since portfolios with heavy positions in private debt see higher yields, it could be a good option to include within an annuity. But the problem with holding it through an annuity is that fees will eat up some of that higher yield, he noted.

So why not remove the annuity from the equation? While liquidity has been a barrier, Bélanger suggested it’s possible to invest in private debt in a more liquid manner, such as a pooled fund trust. More of them are coming onto the market, he said.

And that liquidity could help pension plans maximize returns in many scenarios. For example, if the plan sees a significant opportunity in the equity market, it could divest itself of the private debt relatively quickly, according to Bélanger.


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