AIMCo's CIO Talks Total Portfolio Approach, Private Credit and Risk

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Sarah Rundell of Top1000funds reports AIMCo talks total portfolio approach, private credit, and risk:

Alberta Investment Management Corporation, AIMCo, the $160 billion asset manager for pensions, endowments and insurance groups in Canada’s western province, is developing a total portfolio approach in private assets.

Unlike other Maple Eight investors, AIMCo’s client funds decide their own asset allocation and most of them have reached their target in private markets. Rather than continuing to plough in capital, the investment team are now thinking more about comparing opportunities across assets and anticipating future trends.

“The investment horizon for these assets is long and the ability to rebalance in the future is hampered,” warns Marlene Puffer, who joined AIMCo as CIO in 2023 from Canada’s railway pension fund CN Investment Division.

This approach ensures AIMCo taps sufficient risk but also protects against embedding too much connected risk. Puffer says cross-functional conversations and analysis from the risk team supports intelligent decision-making and avoids unintended consequences.

The team is exploring how different themes cut across different asset classes, she says. The best example is AI which manifests in every corner of the portfolio, but in private markets is encapsulated in red-hot investor demand for data centres. These buildings touch infrastructure and real estate; they hold private equity elements in the construction and development phase; and that are also a renewable energy play.

“We are having more sophisticated conversations around where we want to play in this [AI] value chain and why,” Puffer says.

“It is about making sure we don’t miss part of the value chain because of our definition of what constitutes a real estate or infrastructure investment, or the geographical focus of the portfolio.”

AI is just one example. The total fund approach will touch every point of AIMCO’s strategic direction defined by global diversification, a focus on Asia, integrating climate and new energy opportunities, and garnering more strategic input from partners so that fund investments lead to co investments and direct investment.

“Global diversification, energy and climate opportunities and strategic partnerships all sit in total portfolio management,” Puffer says.

“It is about collaboration and breaking down silos.”

A new approach to risk

The new approach is supported by AIMCO’s rebooted risk culture following losses during COVID-induced market volatility when the investor shed $2.1 billion on a strategy meant to profit from low volatility in equity markets, known as VOLTS. A review found that escalation of the risk of the strategy to senior management and the board was “incomplete” and did not come soon enough.

Now the breadth and depth of risk governance and collaboration has been overhauled, fanning a new risk culture. The investment process involves a two-step approach to analysis whereby anything new coming into the portfolio (a manager or strategy, for example) is discussed first at the investment committee level, before further scrutiny by the investment, risk, legal and sustainable investing teams.

Governance has been reviewed and refreshed. The board has oversight of the risk parameters of every underlying product, and review and set the appetite for risk tolerance and the total fund risk budget. Escalation policies are also now embedded.

New high profile hires include Kevin Bong, senior managing director, chief investment strategist and head of Singapore; and chief risk officer Suzanne Akers who joined in 2022. Puffer says the pair represents a new level of talent and leadership that is now embedded into investment teams, weighing in on due diligence.

“Deals have not been done, or we’ve added more due diligence, as a result of these people,” she says.

There is an independent risk assessment for every transaction and Akers is a voting member of the investment committee.

New C-suite hires have helped build a new culture that encourages psychological safety in all interactions, and open and challenging conversations. Team building and in-person, regular offsites despite the teams being spread around the globe is fostering strong relationships and ensuring everyone pulls towards the same strategic goals. Puffer says gatherings may thrash out strategies, or just focus on building trust and understanding of each member of the team, she says.

“We all know where we are going,” she says.

Private credit is the star of the show

AIMCo’s $7 billion private credit portfolio is another a key area of Puffer’s focus. The investor is expanding its already significant private credit talent base in London and Toronto, with new hires in New York. Maintaining the portfolio’s size, and growing it further, requires stepping up from the small-cap investments made at the beginning and developing large-cap partnerships and deal flow out of New York.

It’s difficult to scale in small cap, she explains. The typical four- to five-year tenor of a private debt deal means around 20 per cent of the portfolio is in perpetual motion.

“You have to feed the portfolio,” Puffer says.

“We are a small team, and feeding it with large-cap deals is more effective. Although it’s possible to scale through small deals, they take up as much time as a big deal and require the same level of talent and staffing.”

AIMCo is one of many investors piling into the asset class which now accounts for some $2 trillion of assets under management. The IMF recently sounded the alarm at so much debt being traded out of the public eye in its latest Global Financial Stability report.

Puffer acknowledges the risk of scaling the allocation in an environment where interest rates are more likely to fall than rise, but she is reassured by an enduring return profile that adds value and provides an alternative exposure to liability matching fixed income.

“Private credit is the star of the show,” she says.

“The sensitivity to interest rates and duration is not the only reason we are in private credit. We are also in it for the credit spread, and for a little extra because of today’s base rate. Even as rates come down, it still has value because it will be down less than our other investments in fixed income.”

Moreover, she says AIMCo has an edge because of the team’s ability to execute. Private credit is shaped around fund investments, yet with each partner the team expects significant co-investment deal flow opportunities. Cue a sophisticated internal team not only with the ability to turn deals around quickly but also a familiarity with its partners and the way they work, and knowledge of the underlying companies.

Puffer will also spend the coming months sizing opportunities in Asia via AIMCo’s new Singapore office, opened late last year. She says fund mangers are increasingly setting up shop in Singapore, enabling new partnerships out of the city state that will lead onto co-investment opportunities, particularly in renewables and diversified infrastructure.

Before I get to Marlene Puffer's comments, make sure you download and carefully read AIMCo's 2023 annual report which is now available here (scroll down toward the end to get PDF version).

On Private Debt, you will read this in the annual report:

Private Debt & Loan invests in private credit as a higher yielding alternative to public fixed income. The products are typically privately sourced and structured, primarily floating rate debt instrument with lower return volatility.

The portfolio generated a 9.6% net return for the year 2023. The return has been persistent and stable in each of the last four years driven by a diversified, resilient portfolio consisting of primarily senior secured, floating rate loans. Compared with the benchmark, the portfolio underperformed largely due to a strong rally of the leveraged loan indices from the negative return of the previous year.

Now, in the article above, Marlene acknowledged there are some risks to scaling into private debt here:

Puffer acknowledges the risk of scaling the allocation in an environment where interest rates are more likely to fall than rise, but she is reassured by an enduring return profile that adds value and provides an alternative exposure to liability matching fixed income.

Nobody really knows whether interest rates are about to decline, stay elevated or rise here depending on what happens with inflation over the next couple of years. 

Does private debt offer important diversification? You bet but it's an awfully popular asset class and opinions diverge on where it's heading in the near term.

Over the past weekend, I noted on LinkedIn that Blackstone’s Zawadzki sees private credit as $25 trillion market:

The $1.7 trillion private-lending industry is still “in batting practice” before it swells to a $25 trillion market, according to one of its powerhouses, Blackstone Inc.

Given the funding needs for financing data centers and energy transition, there’s room to grow to hit the $25 trillion mark, Michael Zawadzki, Blackstone Credit and Insurance’s global chief investment officer said Friday in an interview with Bloomberg Television.

Higher base rates, the shift from banks to private lenders and the proliferation of strategies to access private credit allow the market to grow larger, Zawadzki said. The private investment grade strategies like asset-backed finance and infrastructure credit are “really compelling” in today’s market, he said. The size of the asset-based finance market is about $5 trillion to $10 trillion, he said.

“You’re financing the real economy — you’re not waiting for M&A transactions to happen,” Zawadzki said. “You’re financing consumers, you’re financing data centers, you’re financing energy transition. Huge growth capital expenditures, that’s what’s really driving the growth.”

Blackstone has been active in the asset-based finance markets, leading debt packages for cloud computing firm CoreWeave Inc. tied to assets including microchips. The firm has also increased its exposure to credit card debt, by working with banks such as Barclays Plc on its credit card business as part of an ongoing arrangement.

Spreads in public markets have become “awfully tight” due to investors flowing into the asset class, Zawadzki said. So Blackstone has encouraged clients to enter private credit due to excess spread and the illiquidity premium it offers.

He's not alone. Bruce Richards, CEO of Marathon Asset Management thinks private credit is headed to $15 trillion over the next decade from $1.7 trillion today as types of lending broaden and expand:

“It’s going to be $15 trillion, that same sector in the next eight to 10 years, which is a really big number,” Richards said Thursday at an event at New York University’s Stern School of Business.

Private credit has taken off in recent years, filling a gap as banks stepped back from some risky lending amid tightening regulations. Growth in the industry has accelerating amid strong demand from investors including pension funds, endowments and insurers.

Richards — who is chief executive officer at Marathon, with about $23 billion under management — estimates the market’s true size today may be closer to $3 trillion when leverage is taken into account.

Meanwhile, with asset-backed lending becoming a greater part of the private credit playbook, that subsector could grow as much as 40% a year to become a $6 trillion market, he said. It will be “as big as direct lending when you project out a few years from now,” said Richards. When so-called LME trades are taken into account — or liability management exercises, where struggling companies seek creative financing arrangements to fix existing debt loads— that makes the market opportunity even bigger, he said.

Richards isn’t alone in highlighting a private credit market that’s likely much larger than currently assumed. Apollo Global Management Inc. Chief Executive Officer Marc Rowan has said the total addressable market is about $40 trillion, and that most of the market is not leveraged loans.

“Non-traded – or ‘private’ – corporate and consumer credit can be found on the balance sheets of banks as well as insurers, asset managers, pensions and many others in the investor marketplace,” Apollo describes in a presentation. They cite opportunities across a multitude of lending types, like residential mortgages, auto loans and equipment financing.

Richards said new banking rules that will take effect under the Basel III Endgame regime will be “the propeller that drives” asset-backed lending, because traditional lenders might further step back from certain types of loans. He cited opportunities among a “rainbow of different assets” like aircraft leasing, shipping finance and music royalties.

I have no doubt private credit will boom over the long run but it will also experience hiccups along the way as the US economy falls into a recession and defaults start rising significantly.

In this environment, you need to choose your partners right and I'm confident that David Scudellari, Senior Executive Managing Director, Head of International Investment at AIMCo, and his team are cementing the right strategic relationships.

The article also specifies, AIMCo is taking a total fund approach and risk has been bolstered significantly with Suzanne Akers, the Chief Risk Officer, now a voting member of the investment committee.

Alright, let me wrap it up there and wish all my American readers a beautiful Fourth of July long weekend.

Below, I will share some excellent interviews well worth watching.

First, once again, Michael Arougheti, Co-Founder, CEO & President, Ares Management analyzes the demand for privates including debt, credit and real estate with Bloomberg’s Sonali Basak at the Bloomberg Invest conference in New York.

Next, Katie Koch, President & CEO, The TCW Group and Robert O’Leary, Co-CEO & Portfolio Manager, Oaktree Capital discuss their macro outlooks and the challenges facing credit with Bloomberg’s Lisa Abramowicz at the Bloomberg Invest conference in New York. 

Third, Boaz Weinstein, Founder & Chief Investment Officer, Saba Capital Management speaks on why he’s championing the strategy of closed-end fund arbitrage with Bloomberg’s Sonali Basak at the Bloomberg Invest conference in New York. Pay attention to his comments on private credit around minute 17 but the entire interview is exceptional and well worth watching.

Lastly, Cliff Asness, Founder, Managing Principal & Chief Investment Officer, AQR Capital Management talks to Bloomberg’s Sonali Basak about how AQR is still winning despite today’s wild markets, and how the quant firm has changed in the last decade at the Bloomberg Invest conference in New York. Always love listening to Cliff and jot down notes.

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