Asia’s small and medium-sized enterprises – which account for two-thirds of jobs in the region – faced a $4.1 trillion annual funding gap last year, which provides a big opportunity for investors willing to lend in return for yield, but they also face several hurdles, says a new study.
The Alternative Credit Council, which represents non-bank finance participants in asset management, in its first report on private credit in Asia. The ACC surveyed 28 private credit asset managers in Asia and interviewed 15 of them about how they are navigating the challenges of investing in the region and what role private credit can play amid the rebound from the Covid-19 pandemic.
The report is “a roadmap for private credit investors in Asia”, said Lee Kher Sheng, Singapore-based co-head of Asia Pacific and deputy global head of government affairs at the Alternative Investment Management Association (Aima), an ACC affiliate. He was speaking during a webinar on August 27 to launch the findings.
The private credit market in Asia Pacific is far smaller and has developed more slowly than those in Europe and above all the US, and for good reasons – most notably greater market fragmentation. Partly as a result, allocators often tend to view the region as an opportunistic private debt play rather than a core part of portfolios.
But the ever more competitive global hunt for yield is leading to more interest in Asia’s private credit markets, and growing recognition of the potential opportunity there, among institutions such as Korea's Public Officials Benefit Association.
Driven by an expanding middle class, Asia Pacific GDP grew at 4.5% last year, compared to 1.6% in Europe and 2% in North America, according to the International Monetary Fund.
Accordingly, demand for corporate funding has grown. In 2009 there was $6.1 billion of dry powder and $6.3 billion of unrealised value in private credit assets under management in 2009; last year those numbers had swelled to $16.2 billion of dry powder and $40.6 billion of unrealised value. Globally those figures grew from $475 billion to $812 billion according to alternative investment data provider Preqin Pro.
But still more is needed.
“On the demand side, mid-market companies in the region face a significant funding shortfall. On the supply side, traditional capital providers in the region are unable to bridge this gap due to a rigid financial ecosystem, and complex regulatory environment,” said Jiffriy Chandra, managing partner and chief investment officer of TransAsia Private Capital, quoted in the research.
Asia Pacific accounts for roughly one-third of global GDP, but receives less than 10% of capital allocation to private credit strategies, according to the ACC report.
“From a macro perspective, the private credit opportunities in Asia are superior to [those in] European or US markets. Government debt-to-GDP levels in Asia are healthier and, with some exceptions, Asian responses to Covid-19 have been generally stronger than other regions,” said Alexander Shaik, partner at Hong Kong-based private credit manager ADM Capital.
In Asia, there is still heavy reliance on domestic banking systems to finance economic growth (see chart below), although that status quo is now being challenged, said the ACC report. There is an increasing awareness of the benefits of non-bank funding, especially in relation to its ability to provide flexible financing, it added.
Moreover, global regulatory capital requirements for banks have restricted their flexibility in some markets.
In addition, private debt investments have the added attraction for many that they tend to be shorter-duration – often measured in months rather than years – than certain other alternative strategies, such as private equity and real estate.
However, private debt investments also pose challenges.
“Geographical fragmentation in Asia creates a barrier to scaling private credit funds, unlike in the US, which is pretty homogenous,” said one of the interviewees in the survey.
Indeed, private credit markets in Asia are less liquid than those in certain other regions, which has led to an illiquidity risk premium.
Remote locations, local language and cultural expectations make it harder for asset managers to assess the risks in Asia. On top of this, many companies are family-run, have limited accounting track records or may have complex ownership structures. Hence due diligence must be bespoke, which leads to a perception of increased risk, the ACC report says.
Fortunately, the experienced and more established Asian private credit managers can by and large deliver higher returns than their Western counterparts, said Shaik, perhaps unsurprisingly. The report estimates that typical credit managers expect annual performance of 13% to 20% over a three- to seven-year period.
While the greatest proportion of allocations in the region (41%) comes from institutional investors, family offices (18%) and high-net-worth individuals (15%) are also prominent allocators to Asian private credit managers. In Europe and the US, by contrast, institutional investors typically account for the substantial majority of capital allocated.
Globally 71% of allocations come from institutional investors and only 5% from family offices and 3% from wealthy individuals, according to an ACC report published in 2018.
Interestingly, most investment into Asian private credit comes from outside the region. Some three-quarters (77%) of the capital raised by private credit managers comes from non-Asian investors, notably those in North America (30%).