KBRA releases research examining the growing investment allocations by several of the largest public sector pension funds to private credit—a growing asset class within the larger arena of alternative investments—despite rising interest rates.

Private credit offers public sector pension funds various positive attributes, including higher yields than traditional fixed income, which can provide longer-term benefits if the asset class’s credit and liquidity risks are prudently addressed. Further, while rising interest rates have the potential to negatively impact companies’ cash flows and, ultimately, their ability to make loan payments, investment returns have been sound despite the elevated percentage of floating rate obligations within most private debt portfolios. The Cliffwater Direct Lending Index (CDLI) returned 6.29% for calendar year 2022, and 5.57% through Q2 2023 alone. As such, several state pension plans have continued to add exposure to private credit, now approaching an average target allocation of nearly 6%.

The private credit asset class generally encompasses managed credit funds, collateralized loan obligations (CLO), and business development companies (BDC), with managed credit funds estimated to be the largest of the three subcategories. KBRA is active in each of these areas and has an expansive view of the private credit landscape. Most recently, we published an update of our interest rate stress against nearly 2,000 private middle market companies, most of whom borrow from private direct lenders. We have over 130 ratings for private credit funds, over 45 ratings for private asset managers, over 20 BDC ratings, and over 75 ratings of middle market CLOs and related transactions. From this vantage point, this KBRA report updates our research on the trend of public sector pension funds increasing their use of private credit.

Key Takeaways

• The asset class of private credit is growing, as is its role in the investment portfolios of several of the largest state public pension funds—including several U.S. states.
• Private credit generally has higher yields than the traditional fixed income investments of pension fund portfolios, such as publicly traded U.S. government obligations and taxable investment-grade corporate debt.
• While the prevalence of floating interest rates is beneficial to holders of private debt in an escalating interest rate environment, rising interest rates can negatively impact companies’ cash flow and, ultimately, pressure their ability to make full and timely loan payments.
• Private credit is inherently less liquid, which must be factored into the allocation decisions of pension fund managers.

Click here to view the report.

Related Publications

• Pension Funds Increase Their Allocations to Private Credit
• Private Credit Webinar Recap: Performance and Liquidity in Face of Credit Headwinds
• Business Development Company (BDC) Ratings Compendium: Where Does the Sector Stand on Liquidity?
• KBRA Has a Clear Focus on Credit Ratings, Not ESG Scores

About KBRA

KBRA is a full-service credit rating agency registered in the U.S., the EU and the UK, and is designated to provide structured finance ratings in Canada. KBRA’s ratings can be used by investors for regulatory capital purposes in multiple jurisdictions.

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