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A new solution for a new future: Bringing private credit to DC

Julien Halfon
Head of pension solutions
BNP Paribas Asset Management

The world around us is changing and so are financial markets. Volatility has returned, interest rates have fallen further and the short-term economic outlook is unclear. One constant, however, is the need for a secure retirement for defined contribution (DC) members – and a new future demands new solutions. At BNP Paribas Asset Management, we believe evergreen diversified private credit is one of these solutions as it offers a range of key qualities.

The case for private credit

The depth and breadth of private credit markets give DC investors vast avenues to explore. While public markets may be dominated by large, international companies, private markets are much more diverse, with each security offering its own characteristics that can often be fine-tuned to investor requirements.

Underlying credit types – including infrastructure, real estate, asset-backed securities and mid-market loans – are idiosyncratic in nature, meaning that they diversify well against each other as well as traditional liquid assets.

Loans also span all sizes and maturities, as well as offering a variety of risk, currency and duration profiles. This wide scope means investors can find options to fit most required levels of returns, risk and maturity. Elements of inflation and interest rate protection are often written into credit terms, with floating rate options to hedge rate hikes also possible.

In return for holding these assets for a relatively long time, investors can access higher return streams and dampen overall portfolio volatility. Additionally, private credit generally has lower default rates than equivalently rated investment-grade bonds.

A growing element of DC saving is the environmental, social and governance (ESG) impact of holdings, and private credit can boost these credentials in a wider portfolio. For investors seeking projects that use the United Nations’ Sustainable Development Goals (SDGs) as a lens, private credit is an ideal starting point.

Social housing, UK SME lending and infrastructure enabling the renewable energy transition and the upgrading of transport hubs are all areas in which private credit can help investors make a real, positive global impact.

Breaking down barriers

While many DC schemes have shied away from inserting private markets into their members’ options, there is increasing evidence of their benefits and appetite for them to take another look.

In October 2019, we teamed up with NEST to offer a diversified private credit fund via the master trust’s investment platform, showing how schemes can overcome perceived barriers.

DC investors have traditionally been limited to daily priced funds, yet research shows most savers rarely change where their money is held – just 1% of NEST members changed their investment fund in 2017. Given the long-term nature of pension saving, daily liquidity should not be a high priority, and certainly not at the expense of access to attractive investment opportunities. Investment platforms are urged to innovate to accommodate illiquid investments of this nature.

We believe active portfolio management can also significantly mitigate the risks associated with illiquidity by focusing on diversification and strict credit assessment to access high-quality assets. Our diversified, active approach across sub-sectors means managers can target areas of the market that offer relative value without compromising on credit quality. This approach also allows us to manage cashflow and reinvest more efficiently.

Our multi-asset and quantitative solutions team manages our diversified private credit funds and uses its experience running fiduciary portfolios for defined benefit schemes to focus on cash management, asset allocation and FX hedging.

To improve cashflow management without building up cash piles, we have designed a synthetic approach to offer liquidity and access to listed-bond markets. This is particularly valuable to DC pension schemes seeking ‘evergreen’ exposure to the asset class making monthly contributions.

Access and opportunity

As part of the BNP Paribas Group, our fund managers have privileged access to our global network of experts to provide high quality asset origination in corporate lending, infrastructure debt and real estate. We can negotiate directly with borrowers to construct lending arrangements that are beneficial to our clients, with strong collateral and bespoke terms.

Our investors benefit from a broad blend of underlying private markets and real assets exposure tailored to specific needs, alongside a unique dual proprietary origination model and opportunities for co-investment alongside our wider group.

We embed ESG requirements into credit arrangements, while our proprietary research, taxonomies and scoring methodology allows us to assess risk and best practice for each company or borrower. We believe the future, and the benefits of private credit, should be for everyone.

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