Alternative investments such as private equity and private credit have become core components of institutional portfolios, offering a significant source of diversification and the potential for enhanced returns. Swedish insurance company Afa Försäkring, which oversees more than $20 billion in assets, allocates approximately 20 percent of its total portfolio to alternatives, with about 20 percent of this allocation dedicated to private credit. “The objective of our private credit program is to add diversification across our overall portfolio, but more specifically to complement traditional corporate credit, in addition to achieving higher returns compared to liquid fixed income and credit markets,” explains Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
Afa Försäkring allocates 20 percent of its $20 billion under management to alternatives, including private equity, private credit and a smaller allocation to infrastructure investments. The allocation is separate from the direct real estate investments, which are managed by a different team and fall outside of Lindskog’s purview. “Afa Försäkring has a long track record of investing in private equity, which is where the alternatives exposure began back in 1998,” says Lindskog, who has served as Head of Alternatives for over a year after joining Afa Försäkring in 2019. “Private equity remains the largest component of our alternatives portfolio, currently focused on mid- to large-cap buyout funds and co-investments in North America and Europe, with a smaller portion dedicated to growth and secondary funds.”
Private Credit: A Key Diversifier
In addition to a small allocation in core-plus and value-add infrastructure, the remaining 20 percent of Afa Försäkring’s alternatives portfolio is invested in private credit, primarily through senior secured direct lending funds. This private credit allocation is designed to provide diversification within the overall portfolio and to traditional credit exposure, while also generating higher returns from the illiquidity premium. “Much like private equity, the diversification benefit to the overall portfolio of private credit comes from accessing a substantial portion of the economy and pool of borrowers that are not part of the listed space,” explains Lindskog. “This allocation is largely about diversification, but also about seizing a market opportunity that expanded after the financial crisis due to increasing regulations on banks,” she elaborates. “Today, it has become a very natural part of our portfolio.”
“Much like private equity, the diversification benefit to the overall portfolio of private credit comes from accessing a substantial portion of the economy and pool of borrowers that are not part of the listed space.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
Since the early days of its private credit program, Afa Försäkring has aimed to develop a program with a lower risk-return profile, targeting net returns of six to seven percent. In today’s higher base rate environment, she believes “the target is clearly achievable” without straying too far along the risk spectrum. “We operate in the lower risk-return segment of the corporate lending market, and so far, we haven’t felt the need to venture into more opportunistic areas,” Lindskog explains. “Our investment strategy is highly focused on minimizing downside risk, with a strong emphasis on diversification.”
Private credit has garnered increasing attention from institutional investors in recent years, driven by its “attractive returns, floating rate structure, and appealing spread levels,” among other factors, according to Lindskog. 2023 proved to be a particularly strong year for private credit, with both high base rates and wide spreads creating a favorable environment. “This combination has been very attractive and has further strengthened the fundraising climate for managers,” she adds. While the surge in interest and massive fundraising may present risks for investors, Lindskog remains optimistic and believes “there is still an opportunity for direct lenders to perform well, even as banks and liquid markets have reopened for business again and there is more capital chasing opportunities.”
“Increased competition as a result of stronger traditional lending markets and increased dry powder in direct lending funds has already led to lower spread levels in some parts of the market, but it may also result in less emphasis on protection and weaker documentation and covenants as lenders compete for market share.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
“Increased competition as a result of stronger traditional lending markets and increased dry powder in direct lending funds has already led to lower spread levels in some parts of the market, but it may also result in less emphasis on protection and weaker documentation and covenants as lenders compete for market share,” emphasizes Lindskog. Turning to the borrower side of the market, she notes that the current environment of high inflation and interest rates presents challenges for businesses, “especially for companies that were already struggling during the COVID pandemic and had yet not recovered when inflation and interest rate increases hit.” According to Lindskog, “Lending costs are high, and with the ongoing discussion around a ‘higher for longer’ interest rate environment, some businesses are already under significant pressure, even though default levels remain low by historical standards.”
Manager Selection and Risk Mitigation in Private Credit
This combination underscores the critical importance of manager selection when investing in the private credit space, according to Lindskog. “Our focus on downside protection has led us to favor larger managers,” she explains. “We seek the advantages of scale, which is why we prioritize managers with proven track records, low loss ratios, a strong emphasis on credit quality and underwriting, and experience in managing challenging situations,” Lindskog outlines.
While the selection of underlying managers results from extensive quantitative analysis and qualitative assessments, “the relationship is key, as we expect managers to be part of our portfolio for many years,” emphasizes Lindskog. “It’s crucial that every step of the process works well for all parties involved, so we dedicate significant time to getting to know them, understanding their strategies, and ensuring alignment of interests. Additionally, we focus on their approach to ESG, which is increasingly becoming a natural part of mitigating downside risk.”
“Our focus on downside protection has led us to favor larger managers. We seek the advantages of scale, which is why we prioritize managers with proven track records, low loss ratios, a strong emphasis on credit quality and underwriting, and experience in managing challenging situations.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
Direct lending and private credit differ from private equity in that “you need to identify risks early in the process, as the lender’s ability to influence outcomes once the money has been lent is limited,” explains Lindskog. “We are fully aware of this, and so are the managers. Therefore, we must be rigorous during the underwriting process to ensure we cover those risks,” she emphasizes. Lindskog’s team at Afa Försäkring closely monitors “the growing trend of payment-in-kind and similar arrangements borrowers use to defer payments, which could serve as an early indicator of stress in the market.” This is also an area where the Afa team has observed differences between managers’ approaches.
As the private credit space matures, divergence among managers has become more pronounced. “While it’s still a relatively young asset class with limited long-term data across cycles, we’ve recently observed a greater dispersion than one might expect between different strategies and managers,” observes Lindskog. “Even though we focus predominantly on direct lending, there are still notable differences.”
Although Afa Försäkring has already built a mature and robust portfolio of well-performing private credit managers, Lindskog and her team “remain highly active in meeting with managers in the market to maintain a strong bench of potential replacements and additions to the program.” Similar to their approach with private equity and infrastructure, the portfolio “is the result of many years of relationship building.” In conclusion, Lindskog adds, “We consider private credit to be a valuable component of our portfolio. As long-term investors in this asset class, we see many interesting opportunities across various segments of the market, not just in corporate lending, but also in asset backed strategies such as real estate debt.”
Photo credits: Adam Fredholm/Afa Försäkring.
