Canadian pension funds face shrinking pool of low-risk firms

The tightening supply of high-yielding credit comes as many Canadian institutional investors have been accelerating their exposure to the private debt

Canadian pension funds and insurers are facing a shrinking universe of higher-quality private debt investments to lift returns in a low-yield world, as the coronavirus pandemic has crushed many businesses, while banks maintain lending to better ones.

The tightening supply of this high-yielding credit comes as many Canadian institutional investors have been accelerating their exposure to the private debt.

Private credit is issued primarily by closely held companies, offering a premium over corporate bonds due to fewer disclosures and less liquidity. It is dominated by institutions and high-net-worth individuals.

They offer about 10% yield compared with some 5% generated by Canadian high-yield corporate bonds, according to Deloitte.

That has encouraged institutions including Caisse de dépôt et placement du Québec (CDPQ) and Sun Life Financial to increase their private debt allocations, while fund managers like Ninepoint Partners have seen increased investor demand.

But the pandemic-induced repeated lockdowns have slammed smaller and privately-held business more than their larger rivals, limiting their need and ability to raise debt capital.

Ironically, for the companies that need the help, the banks don’t have the appetite to lend to them, but neither do many private credit funds, said Andrew Luetchford, capital advisory partner at Deloitte Canada.

The dearth of opportunities is pushing institutions to either accept lower returns or invest in lower-rated firms. They are offsetting the risks by including stricter covenants and lowering lending amounts, said Ramesh Kashyap, managing director of alternative investment at Ninepoint Partners.

There has definitely been a ratings migration from higher ratings to lower ratings, said Fitch Ratings Director Dafina Dunmore, adding this is likely to continue through 2021. For firms that are solely focused on investment grade credit... the universe is smaller than it was a year ago.