Orange County Public Employees Retirement System officials are hoping that a loan to little-known companies with poor credit ratings will supercharge the pension fund’s earnings.

Published: Jan. 23, 2014 Updated: Jan. 24, 2014 7:57 a.m.

In the past year, the Orange County Public Employees Retirement System board has agreed to loan $450 million to companies in the U.S., Europe and the Asia-Pacific region, mostly little-known companies with poor credit ratings that need cash.

Officials are hoping the loans, made through investment managers, will supercharge earnings. But they acknowledge some of the investments are risky and each loan’s principal could be lost.

Retirement boards across the U.S. are exploring more exotic investments – well beyond stocks and bonds – to keep pace with promised pension benefits and large unfunded liabilities. Experts vary on the wisdom of chasing high-return investments, but most agree they should be limited in a public pension fund.

OCERS has invested more and sooner in direct lending than most other large public pension funds. Direct lending accounts for slightly more than 4 percent of the assets in the $10.9 billion OCERS fund.

“There’s no such thing as a 15 percent safe investment … There are reasons banks aren’t doing these loans,” said John Shoven, director of the Stanford Institute for Economic Policy Research. “It would be risky in the extreme if this became a large part of the portfolio. But at the 5 percent level, I (would be) willing to take the risk.”

Direct lending is part of the “shadow banking sector,” as one Standard & Poor’s report described it, which boomed after banks slowed their lending. Regulators tightened banks’ requirements, hoping to avert another credit crisis like the one that triggered the Great Recession. With demand for loans outstripping supply, specialized lending funds stepped in and courted institutional investors such as OCERS.

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