Key Takeaways
- • Railpen, which manages about £36 billion for the U.K. railways pension schemes, is tactically underweight public credit and cautious on direct lending, according to head of credit Caroline Hedges.
- • Hedges prefers asset-based finance, shorter duration and floating-rate exposure, and favors sub-investment-grade over investment-grade credit because investment grade "doesn't pay enough for rate risk."
- • Her main concern is AI-linked debt issuance by hyperscalers, which she says are price insensitive, have issued more than the market expected, and could magnify a sell-off if buyers retreat.
- • Hedges says direct lending illiquidity premiums of roughly 150 to 200 basis points are insufficient given valuation and tail risk, with many 2021-22 vintage loans now facing refinancing pressure.
- • Hedges argues public and private credit should be evaluated holistically, not as opposing categories, with investors asking whether they are compensated for underlying risk.
Summary
Railpen is tactically underweight public credit and cautious on direct lending, according to Caroline Hedges, the pension fund's head of credit. Hedges, who oversees credit allocation, said rate volatility, inflation pressure, uncertainty over central bank responses and heavy issuance could push spreads wider. Railpen manages about £36 billion for the U.K. railways pension schemes, roughly 45% of which is invested domestically, according to a press release.
Hedges said credit spreads are structurally tight but all-in yields keep the asset class attractive, with high yield now well above 8%. She noted unusually wide dispersion for a period of tight overall spreads, and said triple-C spreads are trading at distressed levels, reflecting a market that has been effective at differentiating fundamental risk across issuers. Her main concern is artificial-intelligence-related debt. Hyperscalers are price insensitive and have issued more than the market expected, and some of their spreads now trade closer to lower-rated investment grade. She warned that heavy borrowing by a concentrated group of AI-linked issuers could magnify a sell-off if buyers retreat.
Hedges expects inflation to remain structurally higher and has positioned the portfolio accordingly, favoring floating-rate over fixed-rate assets, shorter duration, and sub-investment-grade over investment-grade credit. On direct lending, Railpen's European portfolio is performing well on strong earnings and balance sheets, but Hedges is more cautious given valuation and tail risk. She said illiquidity premiums of about 150 to 200 basis points are not enough, quoting: "I don't think that compensation for giving up flexibility is enough because of the amount of uncertainty." She noted that many direct loans were underwritten during the 2021-22 buyout boom and are now up for refinancing, while sponsors are struggling to exit companies and some borrowers, including less-integrated software firms, face difficult refinancing.
Hedges sees bifurcation across credit markets, with high-quality public sub-investment-grade credits trading tight while a small cohort is more distressed, creating openings for capital-solutions strategies. She favors asset-based finance, where consumer, commercial and hard-asset exposures diversify away from corporate risk. She cautioned that asset-class labels can give an illusion of diversification when many are exposed to the same theme, such as AI. Railpen's credit goal is a growth-oriented, high-yield-like return with a resilient, diversified profile, with private credit allocations drawn from a fund-level illiquidity budget.
Looking to 2027, Hedges expects continued convergence of public and private credit. She said: "In the past there has been a pitting of public credit versus private credit, which isn't the right way of looking at things, given they serve very different, but very complementary roles in a portfolio." She urged investors to assess opportunities across a risk and liquidity spectrum and to ask "whether they are being compensated correctly for the underlying risk, regardless of where it is across the credit universe."
Hedges said credit spreads are structurally tight but all-in yields keep the asset class attractive, with high yield now well above 8%. She noted unusually wide dispersion for a period of tight overall spreads, and said triple-C spreads are trading at distressed levels, reflecting a market that has been effective at differentiating fundamental risk across issuers. Her main concern is artificial-intelligence-related debt. Hyperscalers are price insensitive and have issued more than the market expected, and some of their spreads now trade closer to lower-rated investment grade. She warned that heavy borrowing by a concentrated group of AI-linked issuers could magnify a sell-off if buyers retreat.
Hedges expects inflation to remain structurally higher and has positioned the portfolio accordingly, favoring floating-rate over fixed-rate assets, shorter duration, and sub-investment-grade over investment-grade credit. On direct lending, Railpen's European portfolio is performing well on strong earnings and balance sheets, but Hedges is more cautious given valuation and tail risk. She said illiquidity premiums of about 150 to 200 basis points are not enough, quoting: "I don't think that compensation for giving up flexibility is enough because of the amount of uncertainty." She noted that many direct loans were underwritten during the 2021-22 buyout boom and are now up for refinancing, while sponsors are struggling to exit companies and some borrowers, including less-integrated software firms, face difficult refinancing.
Hedges sees bifurcation across credit markets, with high-quality public sub-investment-grade credits trading tight while a small cohort is more distressed, creating openings for capital-solutions strategies. She favors asset-based finance, where consumer, commercial and hard-asset exposures diversify away from corporate risk. She cautioned that asset-class labels can give an illusion of diversification when many are exposed to the same theme, such as AI. Railpen's credit goal is a growth-oriented, high-yield-like return with a resilient, diversified profile, with private credit allocations drawn from a fund-level illiquidity budget.
Looking to 2027, Hedges expects continued convergence of public and private credit. She said: "In the past there has been a pitting of public credit versus private credit, which isn't the right way of looking at things, given they serve very different, but very complementary roles in a portfolio." She urged investors to assess opportunities across a risk and liquidity spectrum and to ask "whether they are being compensated correctly for the underlying risk, regardless of where it is across the credit universe."
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