Investment actions

Direct lending for the long run

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.


Taking stock

Pension schemes are increasingly taking advantage of the growing direct lending opportunity in Europe. As the market develops, we observe a growing shift from tactical to long-term allocations that are resilient to mid-to-late cycle dynamics and support long-term outcomes. We explore how to build such exposures with a focus on UK pension schemes.

Three conclusions stand out:

1. A consistent potential for better risk-adjusted returns
We find that the growth in European direct lending remains supported by strategic drivers, most notably the continued reduction in bank lending even as we move further into the cycle. The chart below illustrates the structural nature of this trend.

Our hypothetical analysis, based on the average allocation of UK pension schemes over the last ten years, suggests that a long-term allocation would have offered a meaningful enhancement in risk-adjusted return potential.

A structural decline
Corporate bank lending volumes across the eurozone and the UK

The structural decline in corporate lending volumes across the eurozone and the UK

Source: Bank of International Settlements. Loans to private non-financial corporations (PNFCS) data as of September 2019.

2. The importance of an explicit focus on resilience
Key to building long-term exposures is a real understanding of the asset class, coupled with thoughtful portfolio construction based on scheme-specific needs and an explicit focus on resilience.
Two case studies illustrate the importance of crucial ingredients such as prudent return assumptions, sustainability considerations as well as fundamentals-based due diligence and on-the-ground experience.

3. The crucial role of modelling
Building a long-term allocation entails careful risk modelling to ensure the allocation is fully aligned with a scheme’s journey plan. We propose an illustrative outline as a starting point for modelling the inclusion of a direct lending allocation, taking on board considerations such as funding status, cash flow needs and end goal.

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Stephan Caron
Head of European Middle Market Private Debt within BlackRock Alternative Investors (BAI)
Andy Tunningley
Managing Director, leads the UK Strategic Client Team within BlackRock's EMEA Institutional Client Business