Reuters: Regulatory News: UK pension funds take on leveraged loans in search for yield

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UK pension funds take on leveraged loans in search for yield May 17th 2013, 12:57 By Sarah Mortimer LONDON | Fri May 17, 2013 8:57am EDT LONDON May 17 (Reuters) - UK pension funds are dipping a toe into the specialist market for high yielding but risky bank loans in an effort to offset poor returns in their traditional investment portfolios. After years of slow economic growth and record low interest rates, UK pension funds have this year for the first time turned to leveraged loans: they now average 2 percent of their total portfolios since the start of 2013, pension consultants say. Buying up these kind of loans is commonplace in the U.S., where pension funds and insurers have been investing in them since the early 1990s. They currently allocate up to 5 percent of their entire portfolio to leveraged bank loans. But some experts caution that UK pension funds are venturing into a market historically dominated by specialist investors without fully considering the high levels of management required to look after the assets they are buying, which often involve struggling companies or homeowners. Leveraged loans are given by banks to companies and individuals that already have high levels of debt and because of the higher risk of default they carry a higher rate of return. So far pension funds have steered clear, sticking to investment-grade rated bonds on the grounds that leveraged loans' yields were not sufficiently high to counter their risk profile. But now several factors are tempting them in. For starters government bonds and gilts are giving such lacklustre returns, that pension funds are under pressure to look for alternatives. On top of that, pension funds find they can negotiate good buyers' terms because so many banks are obliged to sell these loans on - getting rid of high-risk assets in accordance with new "Basel III" rules which tell lenders to have higher levels of capital to set against the lower-risk loans they do make. Returns from leveraged loans are typically around 500 basis points, or 5 percentage points, over Libor, the daily published rate at which banks lend money to each other. 10-year UK government bonds, or Gilts, are currently yielding around 1.8 percent, while German Bunds are returning around 1.3 percent. FURTHER GROWTH The Western European leveraged loan market is worth around 418 billion euros according to Credit Suisse fixed income research, and growing, say pension experts. Some of the larger European pension funds are already allocating between 1-1.5 percent of their portfolios to loans via specialist fund managers, says Axa Investment Managers. "In the last nine months, we saw 400 million euros of inflows come into our loan funds from pension funds and insurers," Jean Philippe Levilain, head of structured finance U.S. at AXA Investment Managers, said. He expects weightings from investors to increase to 2-3 percent of their portfolio in the next couple years. Dutch pension administrator PPGM has been targeting loans in the U.S. and Western Europe since 2012. The firm currently allocates 13 percent of its high yield investment mandate to bank loans in emerging markets, and 15 percent for U.S. and Western Europe. Overall, loans in both regions represent 2 percent of its 133 billion euro portfolio. "The skills needed are not much different from those required to successfully invest in high yield bonds," Guillaume van der Linden, head of emerging markets credits at PGGM, said. The loans are not as risky as they appear on first glance. The default rate on leveraged loans is 2.8 percent, data from Moody's Investors Service shows. Furthermore, the loans are structured so that pension funds are paid back before other investors if the company defaults. However, the work involved in owning these assets is not to be underestimated, some experts warn. "There's a lot of servicing required by these portfolios, lots of phone calls. You need someone to help each borrower when they request their statement, or if they want to move house... You'd be surprised how much management the 70,000 loans that we service actually takes," said Alex Maddox, head of business origination at debt servicing company Acenden. Nevertheless, a UK survey by Aon Hewitt consultants suggests pension funds are unfazed: 36 percent of respondents were considering increasing their allocation to alternative assets - the category covering bank loans - over the next year. "Until there is a meaningful rise in government gilt yields, interest in this area will remain solid. Pension funds..have a long term strategic interest in boosting their wider bond portfolio," said Tapan Datta, global head of asset allocation at Aon Hewitt. Link this Share this Digg this Email Reprints

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