Corporate direct lending presents a compelling case for inclusion in defined contribution default funds, write James Staunton, head of structured finance Frankfurt at Berenberg, and Phoebe Nguyen, head of UK asset management sales at Berenberg
The UK’s defined contribution (DC) pensions landscape is undergoing a significant transformation. The recently-introduced Pension Schemes Bill 2025 marks a pivotal moment, mandating value-for-money (VfM) assessments, encouraging scheme consolidation and promoting investment in UK productive finance.
One asset class gaining traction in portfolio construction is private credit, in particular, corporate direct lending (CDL). Historically embraced by defined benefit (DB) schemes, CDL has faced barriers to DC adoption owing to platform limitations, liquidity constraints and daily pricing requirements. However, recent developments in fund structures, regulatory clarity and scheme consolidation are changing the landscape. CDL now presents a compelling case for inclusion in DC defaults, offering inflation protection, diversification and return enhancement.
CDL involves institutional investors lending via fund vehicles to mid-market companies, typically to support leveraged buy-out transactions, expansions or refinancings. These debt funds, which are managed by specialist asset managers, increasingly replace the traditional financing solutions, namely bank clubs and the broadly syndicated loan market. Such has been the strength of the CDL offering that debt fund financings now command a higher market share than these traditional solutions.
CDL financings are generally senior-secured, backed by collaterals and structured with covenants and sponsor oversight. Unlike publicly traded bonds, CDL loans are privately originated, usually in partnership with private equity sponsors. They offer predictable income streams and experience lower daily mark-to-market volatility.
Read more: Pantheon targets insurance clients for growth in credit secondaries
CDL strategies now span a broader spectrum of credit quality. While unitranche remains the most prevalent format and typically maps to a single B profile, institutional investors can target more moderate-risk segments. Senior secure loans, reflecting more conservative lending metrics, generally align with BB profiles. At the lower-risk end, super-senior loans benefit from priority ranking and structural protection.
One of the most attractive features of CDL compared to corporate and government bonds is the yield premium. Our analysis of over 500 CDL transactions between 2019 and 2023 compared the yield of the different financing structures super senior, senior and unitranche with both the broadly syndicated loan market and the public credit market. The study revealed that super senior CDL loans averaged around 389 basis points, which is nearly double that offered by similarly rated public bonds.
These premiums reflect not only compensation for illiquidity but also a complexity premium tied to origination, structuring and the ability to provide flexible and bespoke financing solutions. For DC default funds traditionally reliant on public bonds for de-risking or income, this differential offers the potential to enhance net returns without increasing credit risk.
CDL’s floating-rate structure also provides a natural hedge against inflation. Linked to benchmark rates such as SONIA, CDL loans are resilient to interest rate volatility and protective in inflationary environments. This feature is especially valuable for DC schemes managing retirement income drawdown.
From a diversification standpoint, CDL exhibits low correlation with listed equities and public credit, making it a useful addition to multi-asset DC defaults. During recent market stress events, such as the Covid pandemic, rising interest rates and the Ukraine conflict, public bond spreads were highly volatile, whereas CDL spreads remained relatively stable. This is attributable to the more patient allocation of capital, longer-term lending relationships and a stronger focus on underlying credit quality.
Read more: Nearly half of US pension savers would invest in private assets
Risk control is another area where CDL excels. Super senior loans, for example, occupy the top of the capital structure, featuring first-lien security over assets or cashflows, strong financial covenants and rigorous due diligence and monitoring by lenders and sponsors. Berenberg’s modelling of a 50/50 allocation to super senior and senior CDL tranches indicates an expected spread of 475bps per annum (with a value-at-risk (VaR) of 7.6 per cent). This represents an attractive risk-return profile for schemes aiming to improve member outcomes without excessive reliance on equities.
As private debt markets expand, manager selection becomes increasingly important. Berenberg’s key considerations include loan structure discipline, depth of sponsor relationships, origination networks and a proven track record as European market leader for Super Senior.
Berenberg’s CDL fund, for example, focuses on senior-secured and super-senior corporate loans with low leverage, lending to resilient mid-sized companies and maintaining rapid capital deployment with average loan maturities of around three years. Notably, Berenberg’s funds have recorded zero defaults, losses, or value adjustments across €7 billion in transactions since its inception in 2016.
As UK DC schemes enter a new phase of investment evolution, shaped by regulation, consolidation, and a sharper focus on member outcomes, CDL offers a technically sound and strategically relevant addition to the modern DC default.
When implemented with robust fiduciary oversight and through experienced managers, CDL can enhance net returns, improve diversification, provide structural downside protection and offer inflation protection. In an environment where trustees and investment committees face mounting pressure to deliver better outcomes, CDL stands out as a valuable tool in the DC investment toolkit.
Read more: The race is on in the direct lending market
