Yield-hungry pension funds and sovereign wealth funds are stepping in where crisis-hit, regulation-laden banks are pulling back: lending to cash-starved businesses. Pension funds hold more than $30 trillion of assets and sovereign wealth funds some $3-5 trillion, meaning that even a small shift to lending could help fill some of the gap left by bank deleveraging.
One new investment that is increasingly popular among pension funds is direct loans to infrastructure projects, with lending to businesses for exports, mergers or other projects amidst the banking drought also on the agenda. In a major move, APG, asset manager for Dutch civil service pension fund ABP, the largest in Europe, plans to allocate 2-3 percent of its 314 billion euro portfolio to inflation-linked loans in infrastructure, utilities and other corporates.
It made its first ever inflation-related loan for a local road-building project in September. "We are very interested in doing more of these kind of loans because it matches the pension fund liabilities and it offers good risk-return trade-off," Valentijn Thijssen, senior portfolio manager in APG's Alternative Inflation team, told Reuters.
"The fact that banks are more and more reluctant to enter this area does help and makes room for us to come in." To meet the growing liabilities of an ageing population, pension funds need to find better returns than the negative yields offered by core sovereign debt, while sovereign wealth funds are also diversifying to try to generate more cash.
Both can often afford to make longer-term, less liquid investments than many other investors. "What do you do when yields are so low? You can become a lender," said Dale Gabbert, head of investment funds, Europe and the Middle East, at law firm ReedSmith, which acts for sovereign wealth funds including China's CIC.
"What they are saying is: if you buy government bonds or T-bills you are taking risks too, you can lose capital. "If you compare that to lending ... where you could be getting in excess of 10 percent, the risk-return ratio for holding government bonds versus lending with some security, quite often to fairly established businesses, looks pretty attractive," Gabbert added.
The International Monetary Fund estimates that European banks need to deleverage by at least $2.8 trillion in two years to shore up their capital bases, leaving ample room for well-funded investors to step in. Pension funds are not stepping into the sector as fast as banks are retreating, industry experts say, but deals are being struck and interest is growing.
PensionDanmark, which has $23.2 billion in assets, bought a $250 million loan portfolio from Bank of Ireland in June and has mandated J.P. Morgan Asset Management to acquire more infrastructure loans from banks over the next nine months. The pension fund, one of Denmark's largest, also struck a deal last year to make 10 billion Danish crowns ($1.74 billion) available for the funding of export orders through the country's export credit agency EKF. The yield for PensionDanmark is 100-150 basis points above government bonds, the fund said.
"As pension funds, we are challenged by very low interest rates on government bonds and equity markets are very volatile and unsecured," said PensionDanmark's CEO Torben Moeger Pedersen. "So we are in search of assets that provide us with substantially higher yield than government bonds without having to take on the risk on equity markets." He pointed to opportunities opened up by US and European banks seeking to reduce the share of capital intensive long-term loans from their balance sheets.
Bank deleveraging also brings opportunities for asset managers dealing with big ticket investors who do not necessarily have the in-house expertise or staff to make lending decisions themselves, industry experts said. "Increasingly, conversations are focused around how pension funds can exploit the absence of banks and traditional providers of capital, whether it's direct corporate lending or providing senior debt into real estate," said Paul Campbell, CEO of Cairn Capital, which manages over $7 billion.
"Sovereign wealth funds are exploring the same opportunities. It will become a much more plural community - there will be banks, sovereign funds, pension funds." The sovereign wealth fund industry, which manages windfall revenues for future generations for countries from Norway to Abu Dhabi, has been hit by the financial and debt crisis and is turning to lending as part of its efforts to diversify. "We have a mezzanine fund which is drawing strong interest from sovereign wealth funds," said Patrick Thomson, global head of sovereigns at J.P. Morgan Asset Management. "W hen you're able to take a five-, seven- (or) 10-year view on those assets there are tremendous opportunities for higher returns."
Cindy Qu, analyst at Shanghai-based consultancy Z-Ben Advisors, said some of China's sovereign wealth funds have started this type of lending operations. "They don't disclose specific examples but we know they are completing this kind of lending business through their offshore arms," she said.
SWFs are also investing in real estate and infrastructure. Chinese fund CIC made its first foray into UK infrastructure earlier this year, picking up around 9 percent in London utility company Thames Water. Sovereign wealth funds do not face the same regulatory issues in terms of capital requirements as pension funds and insurers, which makes it easier for them to embark on such projects, said J.P. Morgan's Thomson.
Europe's biggest insurer, Allianz, set up an infrastructure debt team in July to tap growing interest from pension funds and others, and hopes continuing EU talks about capital requirements for insurers will facilitate such investments, said Deborah Zurkow, CIO of Infrastructure Debt at AllianzGI.
"Regulators have become very aware of this shift and are trying to adjust their regulations, she said. Boosting pension funds' direct lending may take longer in countries such as Britain, where the government's new "funding for lending scheme" aims to boost loans to businesses, said Graham Neilson, investment strategist at Cairn Capital. "There's more prevalence of investing in infrastructure projects. It is more of an established asset class so it takes less time to set up investment processes, whereas direct lending has traditionally sat with banks," Neilson said.
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