CPP Investments' Credit Boss Warns of 'Bubble-Like' AI Rush
The credit chief for Canada’s largest pension sees signs of “bubble-like” exuberance in the rush to finance AI, cautioning that investors should scrutinize their exposure to the nascent technology.
“You cannot wake up one day and just say, ‘Well, we just had this theme that AI was great, and we woke up and it was 25% of our portfolio,’” Canada Pension Plan Investment Board’s global head of credit investments, David Colla, said in an interview.
Canada’s top pension plan, which oversees C$863.6 billion ($617.6 billion), continues to finance AI-tied projects, including those involving CoreWeave Inc., the largest of the so-called neoclouds that lease out AI chips. But the pension, whose AI investments make up about 3.5% of its credit portfolio, is becoming increasingly selective about such bets.
“There will be winners and losers along the way,” Colla said. “And there’s going to be a lot of volatility.”
Fears of an AI crash have pervaded the market, in part because of the circular financing embedded in many debt packages. Tech giants including Nvidia Corp., Amazon.com Inc. and Microsoft Corp. are bankrolling AI upstarts that rely on the larger companies’ products. That amplifies the backers’ exposure and sets up a potential domino effect if some AI companies go under.
Colla said the pension manager is also scrutinizing the growing use of off-balance-sheet financing structures in which firms create shell companies to take on the debt necessary to build data centers. Lenders need to account for those obligations when assessing borrowers, he said, and they should apply even more scrutiny to privately held AI developers with more opaque finances.
Deep Discounts
The pension fund’s caution on AI contrasts with its willingness to deploy capital elsewhere in credit markets. During a three-week selloff in recent months, it scooped up more than $3 billion in discounted loans and bonds.Colla also sees some of the best opportunities in lending to investment funds. The fund finance market has surged past $1 trillion, according to a report earlier this year from Moody’s Ratings. The boom has been driven by the rapid expansion of private credit and a slowdown in dealmaking that has left buyout firms holding investments longer than expected. “Fund finance is where it’s at,” he said.
Fund finance was once dominated by banks providing short- term loans backed by money that investors had promised to contribute to funds. In recent years, the business has expanded to include more complex loans backed by existing investments, attracting insurers, pension funds and private-credit managers
seeking higher returns.The growth of fund finance has also raised concerns about risk. Moody’s has warned that increasingly complex structures and multiple layers of borrowing could magnify losses if the underlying investments deteriorate. Some newer products have yet to be tested through a full credit cycle.
Colla said the appeal of fund finance lies in combining the pension’s experience in corporate lending and structured credit to evaluate the assets backing the loans and negotiate attractive terms. CPPIB recently completed two large mezzanine financings in Europe backed by portfolios of loans. The deals offer yields of roughly 4% to 5% above benchmark rates, compensating the pension fund for taking on more risk than senior lenders, Colla said.
The pension plan is also expanding into net-asset-value lending, which allows private equity funds to borrow against the value of their investments, rather than sell them. The loans can help managers generate cash while waiting for better conditions to exit their holdings.
CPPIB’s credit portfolio returned 3.8% in the fiscal year ended March 31, with about 67% deployed in the US. Its investments include $265 million in CoreWeave and $1.8 billion in Carlyle Aviation Partners, and it’s a majority owner in alternative credit firm Antares Capital.
When David Colla talks, smart investors listen.
He's the head of the most important asset class at CPP Investments, and when it comes to credit and credit-related matters, he and his team are keenly aware of the full spectrum of risks and opportunities.
Credit touches everything in our economy and nowadays people are worried of an AI credit bubble that's reminiscent of the old Nortel loose vendor financing days on steroids (see this recent BIS paper on circular relationships among AI firms).
If David Colla sees signs of “bubble-like” exuberance in the rush to finance AI, it's probably because his team saw some deals pass through their desk where they didn't participate because the risks far outweigh any potential returns.
Keep in mind, unlike equities, credit departments focus entirely on the best risk-adjusted returns, and they can play across the credit spectrum to attain their objectives. It can be corporate debt, senior loans, structured credit, you name it.
So, just because everyone is financing the AI boom with little to no attention to downside risks, doesn't mean CPP Investments' Credit department will do the same, and that holds for the credit departments at all of Canada's large pension funds.
And to be clear, the article states the following:
Canada’s top pension plan, which oversees C$863.6 billion ($617.6 billion), continues to finance AI-tied projects, including those involving CoreWeave Inc., the largest of the so-called neoclouds that lease out AI chips. But the pension, whose AI investments make up about 3.5% of its credit portfolio, is becoming increasingly selective about such bets.
So, they are financing neoclouds like CoreWeave but are increasingly selective about such loans.
What else? David Colla mentions where they now see the best opportunities:
Colla also sees some of the best opportunities in lending to investment funds. The fund finance market has surged past $1 trillion, according to a report earlier this year from Moody’s Ratings. The boom has been driven by the rapid expansion of private credit and a slowdown in dealmaking that has left buyout firms holding investments longer than expected. “Fund finance is where it’s at,” he said.
...
Colla said the appeal of fund finance lies in combining the pension’s experience in corporate lending and structured credit to evaluate the assets backing the loans and negotiate attractive terms. CPPIB recently completed two large mezzanine financings in Europe backed by portfolios of loans. The deals offer yields of roughly 4% to 5% above benchmark rates, compensating the pension fund for taking on more risk than senior lenders, Colla said.
Let me explain all this in plain English.
CPP Investments is one of the largest institutional investors in private equity in the world. It has relationships with all the top funds, many of which hold great assets they cannot sell now because the macro conditions aren't right (rates persistently high) and dealmaking activity has slowed (exit environment is terrible).
So, CPP Investments' Credit department will evaluate these assets and lend to these PE funds based on these assets on their books (asset-backed financing), collecting a nice spread over senior loan benchmark rates.
It's really not more complicated than that and right now, this is where the best risk-reward opportunities lie.
You have a bunch of funds that don't want to sell assets at a deep discount and need time to sell when the environment is more favourable.
Of course, someone can accuse CPP Investments of lending to funds they invest in to extend their holding period so they eventually produce better returns.
Then the criticism is whether CPP Investments is arguably doing the same circular financing as these AI-firms by propping up PE firms they invest in, lending them money.
Of course, the big difference is CPP Investments is collecting a nice spread here, and if these assets are solid assets, then why not allow the PE firms to hold them longer to realize better returns when the dealmaking environment opens up?
Below, in a shifting credit landscape, agility and collaboration are key. David Colla, Head of Capital Solutions, Credit Investments, shares how CPP Investments is navigating geopolitical volatility, uncovering value in private and structured credit, and using the Fund’s scale and cross-platform expertise to turn market dislocation into long-term opportunity.
Next, Jim Bianco argues that while the AI build-out displays bubble characteristics, it still has many years to run as Wall Street evolves to finance compute infrastructure and data centers. Addressing broader financial markets, he attributes the recent pullback in 10-year Treasury yields to safe-haven flows and notes that the Federal Reserve under Kevin Warsh is undergoing a transition toward less forward guidance and greater voter independence. He also explains persistent public financial pessimism by pointing out that a 35% cumulative rise in prices since 2020 has significantly outpaced the 28% growth in average paychecks.Lastly, Susanne Matern, Head of EMEA Structured Finance at Fitch, and Greg Fayvilevich, Global Head of Fund and Asset Manager Ratings, discuss CFO structures, growth drivers, investors, ratings and outlook.
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