Navigating Asia’s growing private credit markets
As Asia-focused hedge funds underperform and SME funding leaving a lot to be desired, alternative investors are turning to the debt markets…
The private credit market has recently captured the attention of the financial sector, with the number of institutions investing in private debt climbing significantly in recent years.
Although most private credit investors are based in North America and Europe, recent research has found that Asian-based investors are making up an increasing proportion of the sector – nearly doubling from just 6% of active investors at the beginning of 2016 to 11% at the beginning of 2018. The growth within major Asian economies is equally impressive, with private debt investment growing by 36% in South Korea, 52% in China and a stunning 110% in India during the twelve months preceding March 2018.
Why the sudden increase in interest?
Private credit is very much top-of-mind in Asia, with astute investors looking to increase their allocations in this alternative asset class. The private credit market has seen strong growth in the US and EU in recent years, and this trend has carried over to limited partners and investors in Asia.
Asia-focused hedge funds are delivering underwhelming performance, with Bloomberg revealing that nearly 72 percent of funds that posted double-digit gains in 2017 entered into the red in 2018. Operating against the backdrop of a sluggish, low interest rate environment with a lack of SME funding, a number of fund managers are seeking alternative investments, diversifying beyond direct equity by entering the debt markets.
Faced with a number of the same challenges, asset owners, such as insurance companies and pension funds, are also looking to diversify their holdings into safer plays that still offer attractive upside potential.
In addition, given the volatility seen the current global economy—which many fear will persist in 2019—investors are angling towards more liquid investments, even in alternatives. Therefore traditional private equity type vehicles with longer lives of up to ten years are seen as less enticing than debt structures that are geared around shorter-term loans, or those that possess certain open-ended elements.
What’s the upside potential?
Offering steady returns with comparatively lower risk for shorter periods, private debt is emerging as an important component of a strategically diversified investment portfolio. In Asia, where the market is relatively underdeveloped and underserved, many fund managers are trying to enter the market for the first time – but are finding it difficult, as few have these capabilities in-house. As a result, many are looking for third-parties, including administrators, to support their private credit investments in the region. .
In private credit, the focus is on protection of rights, protection of periodic cash flows and protection of principals. While not as flashy as direct equity deals, the predictability provided by steady monthly and quarterly cash flows—soundly reinvested—offers its own return potential.
As a result, the due diligence process is very different. Unlike direct equity investments, private debt investors are usually unwilling to take risk on the principal. Therefore, much of the groundwork must be done upfront, from due diligence to structuring and negotiation of terms and protection clauses, to ensure the underlying investments will generate the desired return profile (i.e. higher income/yield, with principal protection).
What should managers keep in mind?
Managers investing in Asia-Pacific need to take into account country and regional risk, being mindful of the nuances of each market. Even though they may be familiar with the laws, there are shifts in their application. Lenders and investors need a level of certainty that their rights will be protected. This is why many deals still use vehicles established in Common Law jurisdictions.
With all of this in place, there is an additional layer of monitoring and administration work required, such as keeping track of covenants and payments. In cases of syndicated deals, an experienced fund administrator will help to make sure that everyone is getting their fair share.
With Asian investors showing increasing interest in private credit, it’s important to realize that it takes time to build up capability in new markets.
Johnson Har is the head of Hong Kong at Alter Domus, while Jayesh Peswani is the regional head of relationship management at Alter Domus.
Keywords: Private Debt, Private Credit Market, Insurance Companies, Pension Funds, Credit Investment
Institution: Alter Domus