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White Paper: Private Debt - A Solution For Lagging U.S. Pension Performance

February 23, 2021

posted by A.R.I. Venture Debt Opportunities Fund
1mo ago 247

EXECUTIVE SUMMARY


  • U.S. defined benefit pension plans are woefully underfunded at 75% and there are few viable near-term solutions other than improving investment performance.
  • The average assumed rate of return for pensions was 7.26% in 2020, which will be difficult to achieve going forward.
  • Public fixed income performance was buoyed in 2020 by the rally in interest rates but created a massive future risk for pension investors given “what goes down, must go up” eventually in the world of interest rates.
  • One attractive investment solution is private debt, specifically direct corporate loans to middle market and lower-middle market companies.
  • Direct loans possess many features that are attractive to pension investors, including: 1) High risk-adjusted returns; 2) Steady cash income; 3) Portfolio diversification; 4) Capital preservation; 5) Inflation/Interestrateprotection.
  • U.S.middlemarketdirect loans generated annual income of 11.2% and total return of 9.7% from Sept/2004 through Dec/2017.
  • Direct loan risk-adjusted performance has been far superior to equities, government bonds, leveraged loans, high yield bonds, real estate,andprivateequityoverthepast15years.
  • Within private debt, venture debt may have the highest risk-adjusted return of any strategy over the past 15 years. Applied Real Intelligence (“A.R.I.”) estimates that non-bank venture debt lenders returned over 20% annually from 2005 to 2019 with loss rates of 0.25% to 0.50%annualized.
  • Canadian public pension funds scooped up private debt in 2020 as market upheaval from COVID-19 left borrowers willing to offer appealing terms. The increase in private debt is part of a larger push by many pension funds into privately held investments coveted for their high projected returns and diversification benefits.
  • U.S. public pensions have lagged in allocating to private debt strategies. It is not too late for U.S. pensions to reduce funding gaps by allocating more heavily in private debt strategies, including venture debt.