Direct lending has become a cornerstone of institutional private credit portfolios, but investors are increasingly looking to diversify beyond traditional lending to broaden their sources of return. For Afa Försäkring, the Swedish insurer that established its private credit programme in 2013, the next step is exploring opportunities that broaden its exposure beyond sponsor-backed direct lending. “There is room for us to expand the programme to look at more sources of return and different types of strategies,” says Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
“Our private credit programme was established in 2013 and has since become a growing part of the alternatives portfolio,” says Lindskog. The allocation complements traditional fixed income by offering floating-rate income and an illiquidity premium, while extending the portfolio’s exposure to borrowers that are less accessible through public debt markets. “For us, private credit provides a regular source of income as well as an illiquidity premium for investing in private markets,” Lindskog explains. “The regular cash income is also valuable, as it helps support the liquidity needs of the broader portfolio.”
“There is room for us to expand the programme to look at more sources of return and different types of strategies.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
However, Afa Försäkring does not view private credit as a substitute for traditional fixed income. “There is room for both. Afa Försäkring has a large, fixed income portfolio, which provides liquidity and attractive risk-adjusted returns. The fixed income and private credit portfolios complement each other,” Lindskog explains. The illiquidity premium is essential to the investment case, compensating Afa Försäkring for committing capital over longer periods. “To justify committing capital for longer periods, we require additional expected returns, taking account of credit risk, fees and illiquidity,” she adds.
“There is room for both. Afa Försäkring has a large, fixed income portfolio, which provides liquidity and attractive risk-adjusted returns. The fixed income and private credit portfolios complement each other.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
The comparison extends beyond yields. Afa Försäkring assesses expected credit losses, fees, underwriting standards and lender protections, liquidity terms and managers’ ability to handle distressed credits. Private lenders can also play a more active role in restructuring troubled exposures than investors in many public fixed-income instruments. “Direct relationships with borrowers can give private lenders scope to engage in restructurings when difficulties arise,” Lindskog says. As more of Afa Försäkring’s investments have progressed through a full fund life cycle, the insurer is placing greater emphasis on how managers handle setbacks and protect capital when borrowers run into difficulties.
The Credit Cycle Tests Underwriting Discipline
Recent turbulence in business development companies (BDCs), alongside concerns about software valuations, has brought the risks in private credit into sharper focus. Lindskog distinguishes between situations where managers need to adjust valuations to reflect market conditions and those where rising defaults indicate underlying credit stress.
“There’s some indication of stress, which is not unexpected at this point in the credit cycle,” considers Lindskog. Afa Försäkring’s investment framework accounts for an expected level of defaults, recognizing that credit returns must compensate investors for credit losses. Lindskog also suggests that historically low default rates may have understated the risks involved. “The returns we seek from private credit need to compensate us for credit risk, including an expected level of defaults and losses across the market cycle.”
“The returns we seek from private credit need to compensate us for credit risk, including an expected level of defaults and losses across the market cycle.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
For Afa Försäkring, the key question is how managers respond to difficulties and how much capital they can recover from troubled investments, particularly in the senior direct lending market. “There will be important lessons to learn from how managers respond to these situations and how much they ultimately recover,” emphasizes Lindskog.
Expanding the Opportunity Set
While senior direct lending remains an important part of the portfolio, Afa Försäkring is also looking to diversify into other areas of private credit. Lindskog highlights opportunistic credit and capital solutions as particularly attractive strategies, especially for companies facing refinancing needs. “We see a lot of opportunities in opportunistic credit and capital solutions-type of strategies,” she says. These strategies can allow lenders to step in when borrowers need fresh capital but their existing lenders are unwilling or unable to provide financing on the same terms.
“We see a lot of opportunities in opportunistic credit and capital solutions-type of strategies.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
Afa Försäkring is also exploring asset-backed strategies, which provide exposure to loans secured by specific assets or pools of collateral. “There are a lot of interesting opportunities there as well,” Lindskog says. These strategies could help diversify Afa Försäkring’s private credit portfolio and reduce its overlap with the private equity programme, given that a significant share of Afa Försäkring’s direct lending portfolio has focused on lending to private equity-backed companies.
Risks and Lending Standards
Years of strong inflows into direct lending intensified competition for deals and, in some cases, contributed to weaker lending standards. Lindskog points to instances where it seems as if lenders accepted less protective documentation, potentially limiting their ability to influence outcomes and recover capital when borrowers encounter difficulties. “If you don’t have the right documentation in place, that might lead to a risk that you can’t fully compensate for,” she says.
Some of the earlier concerns have since eased. Leverage has declined from the elevated levels seen in previous years, while lending documentation has tightened again as competition has moderated in parts of the market. “Borrower leverage has come down from the elevated levels seen a few years ago, so it is less of a concern than it was, although it remains an important part of our assessment,” Lindskog says. At the same time, there is a broader discussion across private markets around how quickly valuations reflect developments in underlying portfolios.
“From our perspective, one of the reasons we invest in direct lending is to get that steady income, and PIK setups decrease that component.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
Payment-in-kind (PIK) interest is another area Lindskog monitors closely. Under PIK arrangements, borrowers defer interest payments and add them to the outstanding loan balance rather than paying in cash. While such arrangements can serve legitimate purposes, a rising share of PIK interest may signal financial stress among borrowers. “PIK can be used for perfectly valid reasons, but sometimes it can be an indication of stress,” argues Lindskog.
For Afa Försäkring, this matters because direct lending is expected to generate regular cash income. “From our perspective, one of the reasons we invest in direct lending is to get that steady income, and PIK setups decrease that component,” Lindskog says. “For our cash income levels to be sustainable, we therefore want to see a sustainable balance between cash interest and PIK across the portfolio.”
What Afa Försäkring looks for in Credit Managers
Manager selection remains centered on consistent underwriting, experienced teams and the ability to source attractive opportunities without compromising credit discipline. Afa Försäkring looks for managers who maintain their standards even when competitive pressures encourage looser lending terms. “We want to see a consistent underwriting culture throughout the organization, from the top down,” says Lindskog. “Managers shouldn’t simply follow the market. When documentation standards loosen across the industry, we want to work with teams that stay true to their investment philosophy and maintain their standards.”
“Managers shouldn’t simply follow the market. When documentation standards loosen across the industry, we want to work with teams that stay true to their investment philosophy and maintain their standards.”
Marie Lindskog, Head of Alternative Investments at Afa Försäkring.
Experience in restructuring and recovering troubled loans is another key consideration. Managers with dedicated workout teams or integrated restructuring expertise may be better equipped to handle distressed credits, while strong origination capabilities allow them to remain selective rather than deploy capital simply to maintain investment pace. “If you see a lot, you can be selective,” Lindskog says. Managers with broad market coverage and strong origination capabilities may be better positioned to turn down deals that do not meet their underwriting standards.
A Broader Role for Private Credit
Lindskog expects private credit to remain an important part of the financing landscape, with banks’ regulatory and balance-sheet constraints continuing to create opportunities for private lenders, particularly when borrowers need flexible financing or face challenging market conditions. “We expect to find good opportunities in direct lending, but also in capital solutions, special situations and asset-backed strategies,” Lindskog concludes.
This article is part of HedgeNordic’s “Alternative Fixed Income” publication.
