The National Pension Service (NPS) needs an investment strategy that can withstand the market downturn caused by the Covid-19 pandemic when building its overseas private debt portfolio, the latest report from the National Pension Research Institute said.

“Concerns about non-performing assets are rising with some of the companies that raised money from private debt funds being severely affected by the pandemic,” the July 20 report said, pointing out that NPS “needs to review private debt strategies to take into account a credit cycle downturn.”

The South Korean state pension fund began investing in private debt in developed markets late last year, with a focus on direct lending strategies where fund managers extend senior secured loans to companies.

NPS so far has had little incentive to consider allocation to private debt because private equity strategies account for most of the fund’s benchmark for private investments. But its approach changed when the pension scheme adopted a tactical asset allocation program last spring to invest in a diverse range of global alternative assets in search of higher returns.

The private debt market has grown rapidly since the 2009 global financial crisis, especially in the US and European countries where banks retreated from the lending space to reduce their risk and meet stronger capital adequacy requirements.

Global institutional investors have increased their allocation to private debt because it is considered less correlated to public market securities and also offers higher returns than traditional fixed income investments. However, the asset class “has not gone through a major shock such as the global financial crisis to understand its performance during the overall market downturn,” the report said.

The report said NPS should choose fund managers with considerable experience in private debt investing throughout credit cycles. It also stressed that the fund’s offshore private debt portfolio should focus on lowering downside risks with greater exposure to sectors less sensitive to business cycles. (Reporting by Hee-yeon Han)