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Sherilee Mace, executive director and head of LGPS coverage at Pemberton Asset Management examines how the popular and fast-growing Risk Sharing asset class can be a good fit for the Local Government Pension Scheme (LGPS) looking for credit diversification and high running yield.
“Increasing capital pressures on banks make them willing to share portions of their lending books (investment grade loans and SMEs) so that they can free up capacity to continue lending to their preferred borrowers. Risk Sharing transactions allow LGPS funds to access these highly-diversified pools of loans and receive a high running coupon while benefitting from significant downside protection” says Sherilee Mace, executive director and Head of LGPS coverage at Pemberton Asset Management in London.
Risk Sharing or Significant Risk Transfer (‘SRT’) transactions are partnerships between banks and investors whereby investors take a portion of the risk of a portfolio originated and held by a bank in exchange for an attractive premium.
These transactions have proven very popular with pension fund investors as they offer:
- Great diversification benefits: each investment references hundreds or thousands of loans;
- High expected returns: the assets pay floating rate coupons with current spreads around 9% over base rate;
- Downside protection: due to its embedded diversification and structural features, the asset class has proven very resilient to credit losses;
- Alignment of interest: banks remain exposed to the risk of the portfolio alongside investors.
- Article 8 compliant: supports banks away from fossil fuel lending, approach based on data from environment charity. Our investments target financial institutions that are committed to reducing their fossil fuel lending to achieve the net zero targets set out in the Paris Agreement.
Win-win solution for investors and banks
The benefits to investors highlighted above are matched by benefits for counterparty banks. Banks executing SRT transactions free up 70 to 80% of capital on average on the hedged portfolios. This enables them to redeploy the capital to continue lending to their preferred borrowers. The cost for the banks is very competitive versus other forms of capital raises. Banks are therefore willing to pay investors a large portion of their portfolio income for the hedge, well in excess of the spread necessary to compensate for expected losses.
Growing market
The Risk Sharing market has grown considerably over the past 10 years and is expected to continue growing as new bank capital rules (Basel 4) are rolled out from 2025. The increasing number of bank participants and jurisdictions adopting SRT as a capital management tool provide an opportunity for investors to be selective on the banks they partner with and on the portfolios they take exposure to.
Pemberton estimates based on data collected from bank annual reports, stock exchanges and dialogue with law firms, issuers and other market participants. Excludes public-sector transactions.
Pemberton’s approach to risk sharing
Pemberton deploys its deep corporate and middle market credit expertise to negotiate portfolios with banks. As more and more banks enter the market, Pemberton’s local origination network, staffed with senior former bankers, is instrumental in identifying new counterparties and in providing local knowledge.
1 Pemberton estimates based on data collected from bank annual reports, stock exchanges and dialogue with law firms, issuers and other market participants. Excludes public-sector transactions. Estimate as of Jan 2024 for the period 2010-2023. 2 As of 30th April 2024. Includes 8 members of the Investment Development Team.
For more information or to if you wish to discuss any aspects please contact:
Sherilee Mace, Executive Director
This document is about the Pemberton Risk Sharing Strategy and is intended only for the person to whom it has been delivered and is solely for discussion / information purposes and does not constitute an offer or a firm commitment of any kind to provide any investment opportunity, fund structure or return. It should only be used for evaluation of any facts presented herein.
Investment in instruments that the strategy may reference are likely to be long-term and of an illiquid nature. Such instruments are also likely to involve an above average level of risk. This document does not purport to identify all of the risk factors associated with any exposure to such a strategy and prospective investors should make their own assessment of any risk involved in seeking exposure to the strategy or instruments referenced therein. There is no guarantee of trading performance and past or projected performance of the strategy or instruments referenced is no indication of current or future performance / results. The value of investments may fall as well as rise.
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