Why Alternative credit represents an attractive asset class for pension funds

As the new decade approaches, pension plan executives are developing new strategies to drive growth. Plan managers are finding new ways to grow capital with investments in alternative credit. This often ignored, but valuable, asset class represents “an overall investable universe of over $4 trillion in size today” according to research from Ares Market Insights. 

 

US consumer credit represents part of this asset class. These investments are sourced from Market Lending Platforms (MLPs). An MLP is a non-bank entity which serves as a platform for joining lenders and borrowers. In the last five years more than $23 billion in loans have been issued from MLPs globally. More than 50% of this total is concentrated in the US.

 

Here, we look at three reasons why the US consumer credit and the wider alternative credit asset class can offer value to plan managers. We show how alternative credit:

 

1. Can Boost Growth in Tomorrow’s Low Return Environment

2. Can Offer Diversification that is Difficult to Find Today

3. Can Leverage the Power of AI to Source Value

 

Strategizing for Tomorrow’s Low Return Environment

 

The past two decades technology, inexpensive labor, falling tax rates, and globalization have all contributed to substantial business growth. Investors have benefited.

 

Those supports are beginning to crumble.

 

Global labor costs are drifting closer to equilibrium, antitrust measures are on the rise, and competitive differentiators are disappearing. The result: investors can expect to earn less. In fact, research from Charles Schwab suggests that over the next decade stocks and bonds will deliver less than their historical annualized return over the last 45 years.

  

For many plan managers the time to act is now. The fact that The Pension Benefit Guaranty Corporation, a government entity designed to rescue failed plans, is scheduled to run out of cash by 2025, according to their own research, highlights how pressing the situation is.

 

Projections of a low return environment in the future and a destabilized safety net are adding pressure to the role of pension plan manager. By including alternative credit as an asset class, managers have another tool in their box.

 

Finding Diversification That’s Elusive Today

 

As the global economy becomes increasingly connected, investment returns are more correlated. Therefore, factors like tariffs, civil unrest, and geopolitics all influence the returns of investments across different classes. Today, investors need a more sophisticated diversification plan. For many this plan includes alternative credit.

 

By accessing alternative credit as an asset class, plan managers can construct a portfolio that may be less anchored to traditional equity/bond risk factors like economic growth, inflation and liquidity. Additionally, alternative credit gives plan managers the possibility to explore ways to drive asset growth that is not dependent on the few companies driving the broad equity market performance. In one quarter of 2019, just  five companies in the S&P 500 represented more than 30% of the index gains. 

 

In contrast, alternative credit assets, characterized by short-duration and high-yields, have a low correlation to the broader market. 

 

Leveraging the Power of AI Technology to Make Smarter Moves 

 

The data which moves today’s market is vast and nearly limitless. Distilling insights from the data to find the signal in the noise means forming a robust strategy designed to handle the influx of information driving the markets. That strategy is artificial intelligence (AI).

 

AI is up to the task for three key reasons:

 

  • AI offers speed. AI technologies can process, and distill “bottom-line” information from terabytes of data in a fraction of the time needed for traditional computing methods. Quant-based strategies outpace traditional asset allocation and credit risk models.   

 

  • AI helps avoid the bias that creep into human-only investment strategies and serve as a risk mitigation tool which circumvents the unseen leanings.

 

  • AI can offer the predictive power needed to identify the relationship, and level of influence across the countless factors at work in the investment market. 

 

Embracing a 21st Century Approach to Pension Plan Management

 

As the investment market matures, pension plan managers need new tools to grow assets in a way that satisfies their fiduciary obligations. For many, the alternative credit asset class is that new tool because it offers the possibility of accelerated returns and improved diversification, which could be magnified with AI-powered strategies (such as Pagaya’s) that seek to provide scalable benefits. 

 

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Nothing contained in this communication constitutes tax, legal, or investment advice.  Investors must consult their tax advisor or legal counsel for advice and information concerning their particular situation. This article contains certain statements that may include “forward-looking statements.” All statements, other than statements of historical fact, included herein are “forward-looking statements.” Although Pagaya believes that the expectations reflected in these forward- looking statements are reasonable, they do involve assumptions, risks and uncertainties, and these expectations may prove to be incorrect. Actual events could differ materially from those anticipated in these forward-looking statements as a result of a variety of factors. You should not place undue reliance on these forward-looking statements. This article reflects our views and opinions as of the date herein, which are subject to change at any time based on market and other conditions. We disclaim any responsibility to update these views. These views should not be relied on as investment advice or an indication of investment intention. Discussion or analysis of any specific company-related news or investment sectors are meant primarily as a result of recent newsworthy events surrounding those companies or by way of providing updates on certain sectors of the market. Pagaya does stand to beneficially profit from the performance of consumer loans it owns or acquires.  Read the full disclaimer.