By Jonas Wäingelin, NordicInvestor
PensionDanmark, the EUR 30 billion Danish pension fund, has since 2009 increasingly focused on alternative investments and today holds a relatively large portion of assets on the illiquid side. In an interview with Kim Nielsen, head of Private Debt, he explains how he manages part of the alternatives book and what he currently looks for in the space.
Kim Nielsen joined Danish pension giant PensionDanmark in 2011 from Dong Energy´s treasury department where he had been part of the team overseeing the company´s external funding.
At PensionDanmark he joined a small team of four who were responsible for the funds investments into alternatives. “It was just myself and one other person looking at private debt when I joined” says Kim. Today he heads a team of 5 who invest in the illiquid credit markets. In total the Alternatives teams in PensionDanmark is now 16 people plus another 13 who only do real estate in a separate investment division.
“Compared to many others outside the Nordics it is probably true that we have a big allocation to alternatives. We started this drive in 2009-2010 when we made our first transaction in an off-shore wind farm. The low yield environment we are in made us focus more and more on illiquid investment types.” explains Kim.
PensionDanmark invests in traditional asset classes such as equities and AAA-rated government and mortgage bonds and then a fairly sizeable allocation to liquid credit investments such as investment grade, emerging market debt and senior bank loans. These investments together make up the liquid part of the total portfolio.
In the wake of the global financial crisis, PensionDanmark were quick to shift focus and adjusting to the low interest rate environment. Today it has around 20-25 % of its assets in illiquid alternatives.
The illiquid side is divided into two teams; the alternatives team which invests in private equity and infrastructure, and the private debt team which is headed by Kim. The private debt team looks after the illiquid credit investments being credit funds, direct lending, structured credit and distressed debt. Besides fund investments they also do direct and co-investments too.
“We invest in a wide range of assets ranging from AAA-like export agency guaranteed debt up to mezzanine loans where we have co-invested with credit funds.” explains Kim.
“We are a young and growing pension fund with net inflows so the liquidity is not as important for us as it might be in others. In fact for the next 10 years we will have net inflows from our pension savers so we feel that we are well positioned to take on medium term illiquidity both from our credit and equity investments.” Kim says a further explanation
PensionDanmark doesn’t have a minimum guaranteed yield towards their pension savers, “This gives us a bit more flexibility when looking at investments but it also requires us to have a fairly conservative investment strategy. We want to give a stable and competitive return to our pension savers.”
Kim and his team are not bound by working with absolute return targets. Rather the investments are assessed by picking up different types of premiums as compared to what the liquid alternative would yield.
Kim explains “We don’t work with absolute return targets in the traditional sense because there is so much difference between what we invest in the Private Debt segment. Since we do everything from AAA-guaranteed loans to mezzanine loans or in unlisted equity investments in offshore wind farms the risk/return profile is very difficult to fit into absolute target returns for alternatives. The way we look at it is from the point of view of the liquid alternative investment, so we need to have a certain illiquidity premium and complexity premium if we are going to invest through the illiquid markets.
As an example Kim says that investment grade would need to give at least 1-1,5 % above the corresponding liquid investment. He continues “ If we can’t find the right yield pick-up we simply don’t invest”.
The board of PensionDanmark sets the allocation framework where certain amounts are allocated to the different buckets but the teams have a range that they can invest within and still be in compliance with the investment guidelines set by the board.
“We don’t have set allocations, meaning we don’t have to invest a certain amount in a certain bucket of illiquid credit this year. If we don’t see any investments that give sufficient compensation we will invest zero and if the conditions change it could be a large amount.
At present, PensionDanmark runs around 7 billion euro in alternatives. Of those roughly 2 billion are direct investments made in-house and another significant amount managed by Copenhagen Infrastructure Partner – a company Pension Denmark helped seed back in 2012.
This leaves about 3 billion euro which the Private Debt and Alternative Investments team run through external managers.
“We do all manager selection internally and have not used consultants for any of our investment on the alternative side. The market search is done completely by ourselves.” says Kim.
The investment process usually starts with the team discussing a specific theme or asset class, for example direct lending or special situations/distressed debt.
“We make a an analysis of the market situation and the investment propositions available to see wether we think it´s attractive and if the timing is right given where we are in the credit cycle. Basically a thorough asset class analysis which we then discuss with the investment committee or our CIO.” Kim continues “If they agree that a certain segment is interesting we will initiate a search to find all relevant managers. In the asset class analysis we also identify the parameters we are looking for in a manager in a certain space which helps us narrow the field later on.”
Kim and the team always aim to meet all managers available and then through comparing the parameters they identified earlier end up with a short list.
“From there we end up choosing one ore more managers to invest with in a certain space. The final step in the manager selection process is of course to do a thorough analysis of the performance, the team, and operational due diligence of the investment manager and we always use legal advisors to go through fund documentation etc as part of our selection process.”
From starting a search to finalising a subscription takes about 4-5 months. Add to this some time prior when Kim and his team do the asset class analysis and it wouldn’t be a stretch to say they have a very efficient process in place.
A typical fund mandate is between 50 and 100 million euro, although Kim doesn’t have preference for specific investment vehicles. “The ideal vehicles vary depending on what is most efficient for each investment. There are always different considerations around fees, governance, tax and legal that makes one more suitable than another.”
When talking about overall strategies the team tends to stay in mature markets with focus on Europe and some investments in the US.
“What we have been looking at, over the past 12 months, is the US senior direct lending market where we ended up making a segregated mandate. Going forward I think we will spend more time looking at special situations and distressed debt markets to see how that would fit with our overall asset allocation. Both to see if we can improve returns but also if we can get a hedge if the liquid markets turn.” says Kim.
“We have a decent exposure to infrastructure debt having done investments in 2012 and 2013 but as the market has matured and returns have decreased we have not continued to invest in it. We generally like the asset class but not necessarily the returns so at the moment we are quite passive.”
On the continuing popularity of direct lending Kim says that it´s important to understand your own risk/reward profile and to keep in mind that its getting crowded with an increasing number of institutions and funds coming into the space.