The role of private credit in today’s pension landscape

As pensions schemes look to boost both income generation and diversification, non-traditional assets are increasingly in the spotlight. European private credit can offer enhanced yield and lower correlations compared to traditional forms of global fixed income (especially in declining rate environments), plus provide another layer of diversification. In this article, we explore what pension scheme clients need to know about the various types of European private credit.

Private credit: A rapidly expanding asset class

Private credit can generally be defined as non-bank lending. It used to be seen as a niche alternative but is now one of Europe’s fastest expanding institutional asset classes as banks pull back from midmarket and specialty lending due to regulatory pressure.

Common traits of private credit versus public credit include high income and total return potential due to illiquidity, seniority in the capital stack to recoup value in the event of a restructuring, a secured claim on company assets to support capital preservation, and floating rate coupons with low-interest rate sensitivity.

Where private credit assets differ from each other are their underlying liquidity and risk profiles, resulting in different investor experiences and potential levels of expected returns. 

Collateralised loan obligations (CLOs): Customisable risk exposure

CLOs are actively managed portfolios of senior secured leveraged loans, packaged into tranches that distribute cash flows to investors based on a predefined structure. Interest and principal payments are first directed to the most senior tranches, while subordinated debt and equity tranches absorb losses before senior investors are affected. 

A CLO can provide investors with a compelling combination of diversification, structural advantages, and floating-rate income. These vehicles aim to capture the spread between the interest earned on the underlying loans and the interest paid to investors — creating potential for attractive returns.

Investors can choose their specific risk/return profile by allocating between the senior tranches, which typically offer lower risk and yield, or the subordinated debt and equity tranches, which provide higher return potential in exchange for greater risk.

Broadly syndicated loans: Scale and liquidity

A syndicated loan is a collaborative financial arrangement provided by a syndicate of lenders to fund a single borrower, which might be a corporation, large project, or sovereign government. This structure emerges when the financial requirements surpass the capacity of a single lender or when expertise in a particular asset class is necessary. By forming a syndicate, lenders can diversify their risk and access financial ventures too significant for individual lenders.

As they are originated by banks and distributed to institutional investors, syndicated loans offer liquidity and scale, supported by a robust secondary market.

During periods of elevated defaults, loans’ senior and secured ranking at the top of the capital structure has historically resulted in relatively stable returns, higher recoveries and less volatility than junior debt classes.

Direct lending: Additional return from a spread premium

Direct lending means providing capital to companies or businesses without the benefit of an intermediary. They offer a spread premium, typically 100-300 basis points, over syndicated loans due to their lower liquidity and absence of a secondary market. Lenders generally hold the loan until repayment or maturity.

Because direct lending is a buy-and-hold model, active trading in individual loans is negligible, thus eliminating the volatility associated with mark-to-market price movements. Direct lending documentation tends to be highly bespoke as it is designed to reflect the risks unique to each borrower and transaction, rather than a “one-size-fits-all” approach. This is important as it allows lenders to have greater control to force deleveraging, catch problems early, limit cash leakage, and preserve collateral value.

Distressed credit: High risk/return potential

Distressed credit involves investing in the senior debt of companies at significant discounts to par, usually due to perceived fundamental weakness. Returns are generated by investing in companies where, over the longer-term and through various actions, meaningful upside potential can be unlocked. Because distressed credit typically carries higher volatility and workout risk, it tends not to be a priority allocation for pensions. However, pensions may gain exposure to its high return potential as a small component within broader private credit strategies.

Case study: Strategically combining direct lending and syndicated loans in the upper middle market

For illustrative purposes only. Within European private credit, debt provisioned to larger, well-capitalised companies, known as the upper middle market (UMM), may be particularly attractive to pensions given the strength and stability of these corporate balance sheets. UMM borrowers, typically companies with EBITDA of €50 million or more, are well-capitalised and exhibit resilient cash flows, making them a potentially stable and reliable source of floating-rate income.

This segment of the market benefits from a blend of financing options. For some borrowers, direct origination is preferable given the speed, certainty, and flexibility of these facilities. For others, the scale of the syndicated loan market and pricing make it the preferred solution. And for many, they may toggle between the two based on pricing/spread differentials at any given moment in time.

• In times of weak issuance in syndicated loan markets, spreads for new deals widen (as was the case in 2022), and consequently, direct lending deal activity increases.
• Conversely, in times when the syndicated new issue market is strong and spreads are dropping (as observed in 2024),  some upper middle market borrowers may shift away from the direct lending market in favor of syndicated markets.

This dual strategy allows investors to capture the illiquidity premium of direct lending while benefiting from the liquidity and scale of syndicated loans. Moreover, UMM senior secured loans can provide meaningful diversification to predominantly fixed-rate bond portfolios by introducing floating-rate exposure with distinct return drivers. This diversification helps mitigate interest rate sensitivity and has the potential to support portfolio resilience across varying rate environments.

For a deeper dive into the case for the European upper middle market, read our white paper: The case for the European upper middle market

Why Invesco for private credit?

Invesco Private Credit partners with clients to identify attractive opportunities across the credit spectrum. Anchored by a proven, cycle-tested investment process, our 30-plus years of credit expertise support flexible capital solutions — from CLOs and syndicated loans to direct lending and distressed credit. Through disciplined underwriting and customised mandates, we dynamically deploy capital to deliver resilient, differentiated credit exposures.

• Diverse and responsive: Clients can benefit from our full-spectrum credit platform providing flexible tools to pursue specific goals across the risk/return continuum and seize market opportunities in both liquid and illiquid credit, blending public and private exposures for enhanced credit solutions
• Unified platform: We leverage deep relationships and private-side insights to deliver disciplined underwriting, differentiated deal flow, and favorable terms.
• Long-term credit experience: We bring together disciplined investment capabilities and seasoned leadership to serve as a trusted partner across the private credit landscape for all types of investors, spanning individuals to institutions and covering objectives, seeking to cover increased income, capital preservation, and total return. 

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