Arizona Evaluates over $1.5 Billion in Private Credit Investments

The Arizona State Retirement System (ASRS) is evaluating over $1.5 billion in private credit investments to fulfill its 20% target to the asset class, according to a recently released report from the $40.8 billion institutional investor.

As of October 24, 2018, the system had a 16.9% allocation to the Credit Asset Class against its target, with a range of 10-30%. The portfolio is diversified between private debt (12.3%), distressed debt (3.6%), and other credit (1.0%). The benchmark for the portfolio is the S&P/LSTA Leveraged Loan Index (about 6% as of September 2018) plus 250 bps, with the basis points reflecting an assumed illiquidity premium.

This means the expected return of the benchmark is approximately 8.5%, however staff at the retirement system noted that “over time, we believe the credit asset class could generate a 10% IRR.”

In its current search, the system outlined key attributes that any fund manager hoping to do business with the pension must have, including scalable commitments, early termination rights/liquidity options, customized investment restrictions, and an evergreen holding period.

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“We believe there are compelling investment opportunities to exceed the expected performance of the credit asset class benchmark over time in private debt, distressed debt, and other credit,” a report on the investment plan noted. “These opportunities are almost exclusively in private rather than public markets or are in areas of the market, such as distressed debt, which are best approached in locked-up investment vehicles with limited liquidity.

“We do not believe that attractive investment opportunities exist in the public credit markets that will deliver expected returns that will meet the expected return of the Credit Asset Class benchmark over an extended period of time,” the report added.

The ASRS added that the $1.5 billion of new investment opportunities have expected net returns of 12-15%, all of which are in various stages of consideration, due diligence, or legal documentation.

Recently, the retirement system expanded its commitments in the asset class, inclusive of $250 million to expand an existing middle market lending partnership in Europe; $200 million to expand an existing lending partnership in the US for middle market CLO investments; and $300 million for a new partnership to provide small-ticket, lease financing to small or medium-sized enterprises in Europe.

In addition, the pension liquidated its remaining investments with its two high-yield managers from August to October, noting that they were unlikely to meet the credit asset class benchmark going forward. The two partnerships were separate accounts managed by Columbia Threadneedle and J.P Morgan, respectively, and had aggregate returns of 3.8% (one year), 5.2% (three years), and 5.0% (five years). They’ve also begun to withdraw funds from two existing private debt strategies.

The ASRS projects that the credit asset class will grow from 16.6% of the total fund at the end of FY 2018 to 18.4% at the end of FY 2019, and subsequently reach the 20% target by the end of FY 2020. “We expect that nearly all of allocation will be in private markets strategies,” the report noted.

Some of the largest commitments in the credit portfolio are Sonoran Private Credit Opportunities ($1.2 billion), Cactus Direct Lending Fund ($850 million), and Monroe Private Credit Fund A ($850 million).

The pension’s funded ratio increased to 80.4% as of June 30^, 2017, according to the most recently released comprehensive annual financial report.

Tags: Arizona State Retirement System, Pension, Private Credit

JPMorgan Chase Bank has agreed to pay more than $135 million to settle SEC charges that alleged the bank improperly handled “pre-released” American Depositary Receipts (ADRs).

According to the SEC’s cease-and-desist order, JPMorgan improperly provided ADRs to brokers in thousands of pre-release transactions when neither the broker nor its customers had the foreign shares needed to support the new ADRs. The SEC said this resulted in inflating the total number of a foreign issuer’s tradeable securities, which led to abusive practices such as inappropriate short selling and dividend arbitrage.

ADRs require a corresponding number of foreign shares to be held in custody at a depositary bank. However, the practice of pre-releasing ADRs allows them to be issued without the deposit of foreign shares, as long as the brokers receiving them have an agreement with a depositary bank, and the broker or its customer owns the number of foreign shares that corresponds to the number of shares the ADR represents.

However, according to the SEC, JPMorgan pre-released ADRs to brokers when the firm was negligent as to whether the pre-release brokers, or the parties for whom the ADRs were being obtained, beneficially owned the corresponding number of ordinary shares.

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“The result of this conduct was the issuance of ADRs that in many instances were not backed by ordinary shares as required by the ADR facility,” said the SEC in its order, adding that the conduct violated Section 17 of the Securities Act.

The SEC said JPMorgan conducted pre-release transactions that were often outstanding for periods of time that would not result from typical inter-jurisdictional settlement disparities. For example, it said that between late 2011 through mid-2014, among more than 14,600 pre-release transactions, 7,000 were outstanding for more than five days; over 1,300 were outstanding for more than 30 days; and more than 400 were outstanding for over 100 days.

“Based on the durations of its pre-release transactions and the manner in which the transactions were closed, JPMorgan should have recognized that pre-release was being used in connection with trading strategies that had nothing to do with settlement timing disparities,” said the order.

The settlement is the eighth action against a bank or broker, and fourth action against a depositary bank, levied by the SEC in its ongoing investigation into abusive ADR pre-release practices.

“With these charges against JPMorgan, the SEC has now held all four depositary banks accountable for their fraudulent issuances of ADRs into an unsuspecting market,” Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office, said in a release. “Our investigation continues into brokerage firms that profited by making use of these improperly issued ADRs.”

Although JPMorgan neither admitted nor denied the SEC’s findings, the bank agreed to pay disgorgement of more than $71 million in ill-gotten gains, plus $14.4 million in prejudgment interest, as well as a $49.7 million penalty.

Tags: American Depositary Receipts, JPMorgan Chase & Co., SEC