By Hamlin Lovell, NordicInvestor

This article forms part of our upcoming report on Alternative Fixed Income

Afa Försäkring (Insurance) manages approximately SEK 220 billion (USD 22 billion), for its 3 insurance companies and a small number of external foundations.  The alternative credit program is focused on direct lending. Hamlin Lowell spoke to Head of Alternative Investments, Mikael Huldt, about the criteria for selecting managers.

AFA do not classify liquid high yield debt as “alternative credit”, the allocation is only to direct lending and has been stable at around 3-4% of total assets. This also represents about 25% of the alternatives allocation, which is 16% of total assets.

“We allocate to alternative credit as a fixed income replacement and for illiquidity premia, rather than for inflation protection or liability matching,” says Huldt.

Return targets and risk premiums

The long-term return target is typically 6-7% per year over a five year cycle, in Swedish Krona because the other currency exposures, such as USD or EUR, are hedged back to SEK.

Nearly all – over 90% – of the direct lending allocation is linked to floating interest rates, so their yields should track interest rates higher, and Huldt does expect yield to rise.

In absolute terms, as of May 2022, the direct lending strategy provides yield pickup of around 2% above more liquid loans such as senior secured loans. In terms of spread per turn of leverage, the average leverage multiple is around 5 times EBITDA, so the extra spread per turn of leverage works out at 40-50 basis points.

Huldt judges that, “the return premium is mainly for illiquidity, and partly because the borrowers do not have a credit rating. We do not believe there is much if any complexity premium involved: These loans are not very complex and are not special situations or distressed. There might however be some degree of structuring or sourcing premium for off the beaten track loans that other lenders, such as banks, are not prepared to make. Borrowers are also willing to pay higher yields for speed and certainty of execution”.

Longer lockups

The direct lending funds AFA invests in are at the longer-term end of the spectrum, with lockups of 7-8 years. Huldt is aware that secondary markets are starting to develop, which might allow for some trading of loans prior to their maturity, especially in equity like and special situations loans, but he does not anticipate availing of this in any large scale. The secondary market for fund interests in private debt funds is also developing, albeit at an earlier stage.

Short term cash awaiting deployment simply sits in cash, no liquidity management products are used for yield pickup.

Default and refinancing risks

His greatest fears in May 2022 are, “a default wave leading to a high degree of losses. There is also a danger that if companies find themselves shut out of the refinancing markets, they may resort to private debt, which might in some cases impact credit quality. We would rather avoid too much refinancing of such borrowers. Credit underwriting is key”.

Regulatory risk

He is also conscious that regulatory risk could be increasing, partly because new AIFMD II rules are targeting private debt funds and increase scrutiny: “If smaller managers find the new rules harder to navigate, they could encourage consolidation and mergers with larger managers. However, we still think that regulators should be realistic with their demands, because they recognize the need and economic importance of alternative lenders providing capital for SMEs and thereby stimulating economic growth”.

ESG: mainly SFDR 8 and Exclusions

Most of the funds are making disclosures under SFDR article 6 or 8, with a few in category 9. “The category 6 ones are expected to migrate to category 8 in due course. Article 9 is nice to have, but not a must have for impact strategies. It can be difficult to navigate whether they are inside or outside the Article 9 rules,” Huldt explains.

ESG exclusion criteria can be more important than positive impact. “Since private lenders do not control companies, they cannot always have as much influence as private equity investors,” points out Huldt.

Sustainability linked loans

However, there are some exceptions. Sustainability-linked loans are an example where lenders lower interest rates in response to certain ESG enhancing activities or Key Performance Indicators (KPIs). Does this imply sacrificing some returns? Not necessarily on a risk-adjusted basis. “AFA can allocate to these strategies on the basis that improving sustainability makes the business model less risky and thereby improving the credit quality. A better ESG profile is also great for equity holders,” says Huldt.

Where is it is possible to measure impact, AFA is emphasizing environmental and social SDGs, including carbon footprints, which are mainly scope 1 and 2 for now.

Ongoing monitoring facilitates efficient due diligence

AFA’s private debt investments date back to 2007, but in 2015 they started with a dedicated allocation to the asset class. The same standardised process is applied to due diligence for existing and new managers. “It typically takes around 6 weeks but this is not a completely fresh exercise. It is only possible to complete DD within a month because we have our eyes and ears on the market, and managers have been on our radar for a long time. We are continuously monitoring and market mapping as part of our outreach so we do not have to start from scratch. We can then allocate quickly,” explains Huldt. Operational due diligence is done in house, though AFA do use external advisers for tax and legal aspects.

Sourcing comes from networks and selected external parties: “we use conferences, data sources, references and third-party marketers, to generate ideas, but not consultants nor gatekeepers”.

The alternatives team meet 150-200 managers per year including private equity and infrastructure, of which 40 (25-30%) are private debt managers. Some 5 or 10 of them might be new managers with whom AFA has not met earlier. All allocations were, by definition to new managers in 2015, but no new allocations were made in 2021.

When assessing new managers, Huldt likes to see teams who worked together and who have portable track records. “There is no hard minimum on the length of the track record, but it should have covered at least one downturn or economic cycle. We are at the lower risk end of the alternative credit risk spectrum. We like to see managers with strong credit underwriting skills and who have managed and navigated defaults and restructurings, and avoided difficult credits and losses,” says Huldt.

Fund sizes

Fund sizes are typically USD 2-10 billion. A typical ticket size of USD 75 to 100 million, combined with a requirement to not be over 10% of a fund, effectively sets a minimum of 1 billion. In practice, AFA is rarely more than a few % of any fund.

Well known onshore and offshore domiciles

AFA allocate to North American and European direct lending strategies. Some of the US managers have set up a European vehicle and others have not. Vehicles are mainly separately managed accounts, and illiquid closed end funds. The domiciles can be offshore or onshore, and the three main ones have been Cayman Islands, Ireland and Luxembourg.


In mid-2022, Huldt has noticed some upwards pressure on direct lending yields, but spreads are not tracking reference rates one for one. “If the reference rate goes up by 1%, the all in yield might rise by 0.5%. However, we are focused on the performing end of the corporate credit spectrum, so the experience might be different for stressed and distressed,” says Huldt.

The opportunity set is compelling: “the market for private and alternative credit and private debt remains very interesting. Most managers have navigated the pandemic fairly unscathed. The main fundamental driver remains as banks are retrenching, and increasingly borrowers not being able to refinance debt in public markets – or perhaps not being willing to given the volatility,” concludes Huldt.