“It’s a combination of banks vacating that space and pensions looking for yields,” Shackelford said. Wider spreads and regular cash distributions with investor protections in the event of bankruptcy have made private credit attractive, he said.

The growth of private lending and the lurch toward alternative assets by state and local pensions both trace back to the 2008 financial crisis.

Regulators tightened rules on risky lending by deposit-taking institutions and in response banks have pulled back. That’s provided an opening for private credit. Meanwhile, state and local retirement plans’ funding tumbled from 92% of total long-term liabilities in 2007 to 62% in 2009 as equity markets plunged, according to Equable. Massive shortfalls still persist: The largest 225 US public pensions face a $1.4 trillion gap between the assets they hold and the tally of their future benefit commitments, Equable data shows.

State and local pensions sought to plug funding gaps by increasing holdings of alternative assets such as private equity and real estate to more than a third of their portfolio. With private credit now a serious rival to mainstream lending, public pensions are giving it more of a hard look, too.

“They did toehold investments in private credit going back a few years,” said Stephen Nesbitt, chief executive officer of Cliffwater. “Now, this is real.”

Nesbitt predicts US state pension assets invested in private credit will double in the next two years to about $200 billion as the taxpayer-funded retirement systems increase target allocations.

To be sure, alternative investments overall haven’t been a panacea for retirement plans. A study of public pension funds from 2001 through 2022 found that “the increasing reliance on alternatives certainly has not helped, although it may have dampened reported volatility,” according to a November 2022 report from the Center for Retirement Research at Boston College.

Amid the excitement over private credit, financial heavyweights from JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon to UBS Chairman Colm Kelleher are raising concerns about the market. Executives from investment powerhouse Pimco have warned about the lack of regulation. The International Monetary Fund in an October report also cautioned about the opacity and potential risks.

Guillette at Segal Marco Advisors said questions are starting to arise about the value of adding more complicated assets from private markets when public markets such as plain-vanilla bonds now offer strong potential. Bond markets as a whole have posted blockbuster returns in recent weeks, for example.

For many, the potential benefits are too big to pass up. Some, though, are taking a measured approach. North Carolina Treasurer Dale Folwell sees opportunity in private debt but he added that the state is cautious about balancing safety with returns. The state pension plans for which he is responsible hold roughly $1.75 billion in private credit out of overall assets of more than $115 billion.

“There are very robust conversations” how dollars are divvied up between alternative investments such as private equity and private credit, Folwell said. “It’s just a very high level of conversation about what brings the best long-term value to our pensioners with the highest margin of safety.”

This article was provided by Bloomberg News.

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