Kentucky Eyes $200 Million Controversial Investment in Direct Lending Firm

As investors consider how to rebalance in a post-pandemic world, an investment committee at the Kentucky Retirement Systems (KRS) approved a motion Wednesday to allocate $200 million into a direct lending firm, although the idea made some panel members skittish.

The pension fund is considering an allocation to Blue Torch Capital, a direct lending firm that buys debt from middle market companies that are in the process of restructuring and are in need of cash. Direct lenders provide loans to businesses without intermediaries such as banks.

Founded by former Cerberus Capital executive Kevin Genda, the private debt investment firm buys senior secured first lien debt—meaning the lender will be the first to be repaid if a company defaults—from businesses with at least $100 million in revenue.

Blue Torch charges a fee of 75 basis points (bps) of interest rate for managing the assets. Any profits after reaching an 8% preferred return would be split between the two, with KRS getting 80% and Blue Torch claiming 20%.

The capital deployment will be reviewed when the full KRS board meets early next month.

The strategy is considered attractive for some on the KRS investment team who are looking for new opportunities, particularly after an upswing in markets last week. But not everyone from the pension fund was convinced it was a good deal, fearing direct lending is too risky.

“Now is the time you need to take risk,” Rich Robben, chief investment officer at KRS, said during the teleconferenced meeting advocating for the private equity firm. “The day we’ve been waiting for is here, and now we need to go deploy that capital.”

The retirement system had $3 billion in fixed income and cash equivalents going into the coronavirus crisis. But KRS, which is worth $17.5 billion, has a number of underfunded pensions that range from 13.5% to 49%.

Other members were uneasy, given continued turbulence in financial markets. JPMorgan shares dropped 5% on Tuesday after the firm added $6.8 billion to its credit reserves, signaling to its investors a surge in defaults in its lending businesses, such as in retail and real estate.

“That’s a bad market,” said Kelly Downard, one of two members in the team who did not approve the board motion for the fund allocation. He urged the eight members on the call to consider waiting six months to see how the economy fares before allocating funds.

“We have not seen this market ever before,” Downard said. “Everyone keeps talking about 2008-2009. Those were financial issues, financial problems in the market. These are supply chain issues.”

But others emphasized the importance of moving quickly in a down market. “If we were to wait six months, a percentage of the opportunities will be gone,” Robben said.

Proponents argued that asset manager Blue Torch insists on tight covenants, which are lending restrictions on borrowers’ behavior meant to prevent them from risky activity that would endanger their ability to service the debt. Blue Torch painted this as an advantage over public markets, where companies too often lack such restrictions on their debt.

The investment team also approved a motion to liquidate the entirety of its Treasury Inflation-Protected Securities (TIPS) portfolio, given historically low Treasury yields and very low inflation.