London CIV, the £31.6bn pool for the London boroughs and the City of London is due to launch a new private credit strategy in the third quarter. Vanessa Shia, head of private markets for the pool sat down with Room151’s LGPS editor Mona Dohle to discuss why the pool is expanding beyond senior direct lending.
What prompted you to initiate a new strategy that goes beyond direct lending?
Our first private credit vehicle, which we launched in March 2021, was purely focused on mid-market senior direct lending in Europe and the US.
By March next year, we’ll be approaching the end of ramp-up period, but the fund is effectively closed to new investments from our partner funds. This move is driven by demand from our partner funds. Many clients have expressed a continuous interest in private credit, and we currently lack an open vehicle for new investments.
Historically, partner funds have focused on senior direct lending. However, based on our market research, which included meetings with over 100 managers and an assessment of the credit cycle, we identified a complementary opportunity to senior direct lending. That is why we proposed launching a new vehicle different from our first private credit fund.
So, this initiative is based on increased demand from partner funds for private credit?
Yes, our approach is very client-driven. In asset management, launching a fund without client demand wouldn’t be viable. For this private credit vehicle, my team and I have built a large network of GPs and LPs, positioning us strongly to launch a product suitable for the current economic environment. This product is also future-proofed, allowing us to invest across different strategies, some of which may not be investable today but present interesting opportunities.
What are those strategies, and how does this differ from the existing private credit fund?
We have what we call a “seed investor group” where we involve partner funds interested in a new vehicle. The investment team proposes an investment strategy and portfolio construction process. For this vintage, we plan to allocate 70% to senior direct lending and up to 30% to asset-based lending. While the primary focus will be on Europe and the US, the fund will have the flexibility to opportunistically invest in other OECD countries, though this won’t be a core allocation.
The fund is a closed-ended vehicle, responding to client fund demand, with a ten-year term and a one-plus-one structure. This extends the fund’s lifetime by about two years, providing more headroom to continually invest in prime credit areas.
On a broader note, we are noticing more open-ended vehicles being launched, which we may consider for future allocations to credit.
What is driving the trend towards open-ended structures in private credit? Do you think there’s a desire to expand these strategies more rapidly?
Currently, our partner funds prefer closed-ended funds, partly due to concerns about potential dilution in open-ended funds. Some partner funds favour open-ended vehicles for the flexibility to invest later and ensure continuous availability of investment funds.
Open-ended vehicles suit credit well, as echoed by many managers. Private credit is a cash-generative strategy, allowing continued investment and potentially higher returns. However, many of our partner funds are content with reinvesting income rather than extracting it now. In closed-ended funds, liquidity and allocation timing need careful consideration, an issue less relevant in open-ended funds, which we might consider for our third vintage.
Is this an example of the compromises you have to make with 32 shareholders?
Exactly. It’s challenging to align every partner fund’s perspective on opportunities and optimal fund structures. Finding middle ground is essential, which is why we opted for a closed-ended strategy but added one or two years for additional investment flexibility. Open-ended is likely the future in this market, with more GPs launching evergreen strategies.
Can you tell me which partner funds have committed?
Several pension committees will convene over the next few months. Once the fund is launched, many of our partner funds will bring the LCIV Private Debt Fund II to their pension committees, however we are unable to share any names of partner funds.
What is the target size of the fund?
The target is still evolving but we are hopeful the target fund size will be larger than our first vintage. We aim to bring a product to market quickly to meet our partner funds’ time requirements.
Can you disclose the names of the managers you will be investing with?
Unfortunately not as we have not finalised any commitments with managers at this stage.
Looking at the macro picture, what do you think is driving the strong demand for private credit from partner funds?
High rates, reflected in the low double-digit returns many managers currently generate, drive demand. Even in a slightly lower interest rate environment, strong performance and returns persist. High single-digit returns remain achievable, making it an attractive strategy, even if rates drop.
Let’s talk about the 30% allocation in your fund beyond senior direct lending. Why is allocating to different strategies important in the current market cycle?
Key aspects in private credit include scale and diversification. Traditionally, partner funds have favoured senior direct lending due to its maturity and scalability. Asset-based lending complements senior direct lending and can also be scaled. We observe a retrenchment from traditional lenders and an emergence of new managers in this space.
Asset-based lending diversifies our portfolio, covering areas such corporate to consumer debt, credit card receivables, and trade finance. The deployment potential in asset-based lending is strong, focusing on quick deployment, which is important to our partner funds.
You mentioned deployment. There is a huge amount of dry powder in the market. Is that a concern for you?
In private credit, we see managers fully committing within their investment periods, so I don’t think it’s an issue. As investment professionals, ensuring we adopt a nimble strategy is crucial for capital deployment. Maintaining a pipeline of managers and market engagement is key.
Our fund selection process involves scrutinising managers’ track records and risk management to gauge capital deployment efficiency. It’s not just about quick deployment but also ensuring investments are in the right deals and sectors. Since Covid, we have increased out focus on understanding sectors and geographies, loss and recovery rates, and managers’ processes to minimise losses. These are critical factors we can control.
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