Värde Partners is to launch a fund dedicated to buying ‘scratch and dent’ real estate loans in the US.

The private equity manager has attracted $150m (€110m) from Pennsylvania Public School Employees’ Retirement System and will launch the product in the third quarter of the year.

The Värde Scratch and Dent Fund will focus on real estate loans typically smaller than $10m with high loan-to-value ratios, low debt service coverage and occasional missed payments.

It is the first such fund for Värde, which acquired special servicer First City Financial Corporation last year.

According to board meeting documents, Pennsylvania PSERS does not consider the Värde Scratch and Dent Fund to be a private equity fund because of its targeted returns. The fund is expecting returns of 10% to 15%; private equity funds have a blended IRR in the range of 18% to 21%.

But the pension fund has identified it as a strong investment opportunity. The secondary market for the type of loans is estimated to be over $100bn with more product expected to be created over the next five years.

The loans are currently held by banks and CMBS special servicers. These institutions are motivated to sell loans up to three years prior to maturity due to regulatory pressure, lack of workout resources, unwillingness to reserve property capital levels or concerns that the loans will become non-performing, according to the document.

Most of the assets in the commingled fund will be located in the US.

Värde is aiming for a total capital raise of $300m to $500m.

The limited partners in the fund are anticipated to receive semi-annual distributions of income with an expected annual yield of at least 8%.

The commitment by Pennsylvania PSERS represents a new relationship for the pension fund.