Asset owners and fund managers are eagerly adding to a wall of capital for distressed debt and special situation investments in Asia, with a proliferation of new teams, allocations and licence approvals in recent months and more expected to follow.
China and India are seen as the most fertile markets for such opportunities, with the authorities in both countries acting to reduce the amount of bad loans sitting on banks’ books. The number of debt defaults is expected to rise thanks to slowing economic growth, particularly in China, and widespread expectations of a US – if not global – downturn within the next couple of years.
“There are a lot of reasons to think that Asia could be the epicentre of the next distress cycle and that there will be a lot to do there,” Brian Dillard, head of Asia credit at alternatives giant KKR, told AsianInvestor.
He cited the rapid growth of the region’s debt market. “You can’t have that amount of credit creation without creating a lot of NPLs along the way,” Dillard said.
Over the past 10 years, the US dollar-denominated corporate bond market in Asia ex-Japan (as represented by JP Morgan’s Asia Credit Index) has more than quadrupled in size, from $206 billion at the end of 2009 to $872 billion as of end-2017, according to Goldman Sachs.
Los Angeles-based distressed debt specialist Canyon Partners is expected to obtain a regulatory licence in Hong Kong in the second quarter of 2019, a source familiar with the firm told AsianInvestor. That's after Seoul-headquartered private equity firm MBK Partners and New York’s Cerberus Capital both won approvals from Hong Kong’s securities watchdog in the second half of last year.
Asset managers need licences to invest into private debt because it involves investment in publicly listed securities, but that is not the case for private equity.
In addition, Texas-based Lone Star Funds, a specialist in non-performing loans (NPLs), is understood to be expanding its team in Hong Kong with a focus on China’s NPL market, where it has made a number of investments in the past year or so. For example, Steve Bernstein relocated to Hong Kong from Japan as managing director of portfolio management and operations early last year.
Lone Star declined to comment for this article. Neither did the three other firms, which have also added credit specialists in the city in the past 18 months – although MBK’s co-founder and partner, Michael ByungJu Kim, did outline the firm’s rationale for moving into distressed assets in a letter to investors issued in March last year.
Law firms appear to see the potential too. Several have added litigation staff in Hong Kong and Singapore and opened offices in China for the same purpose, said Sean Scott, a partner at MJ Hudson, a London-based law firm and asset management consultancy.
That is perhaps an indicator of an expected increase in activity in distressed opportunities requiring restructuring and insolvency experience, he told AsianInvestor.
Demand is also rising for distressed and special situation assets in India. Abu Dhabi Investment Authority (Adia) and German insurer Allianz, for instance, have both recently committed capital to such strategies.
Earlier this month Adia set up its first India special situations fund with $500 million, in partnership with Kotak Investment Advisors, while Allianz said in February it had committed $200 million to Mumbai-based Edelweiss’s second India special assets strategy.
Meanwhile, Cerberus and another US alternatives firm, Varde Partners, opened offices with special situations capabilities in Mumbai earlier this year, while Hong Kong’s PAG is reportedly planning a similar move. Moreover, KKR added two credit specialists to its Mumbai team in December with an eye on similar opportunities.
Cerberus and PAG did not respond to requests for comment.
Increased capital-raising activity reinforces the overarching trend. A raft of Asia-focused distressed debt and special situations funds closed in the past six months, from the likes of Avenue Asia, Cerberus, Edelweiss and Varde. As of December, there was $8.4 billion in dry powder poised to go into such assets in Asia, according to research house Preqin.
And at least nine managers are currently in the market with Asia-dedicated funds targeting an aggregate amount of $6 billion-plus to invest across distressed assets or special situations, by Preqin estimates (see table below).
MBK is raising its first special situations fund, with a focus on China, Japan and South Korea and a target of $1 billion. In his letter in March last year, Kim pointed to “a surge in distressed or stressed opportunities but, importantly, with limited competition. The deal surge is being driven by increasingly limited access to liquidity, given regulatory constraints on bank balance sheets.”
There is, unquestionably, more competition and investor demand for such assets now – perhaps unsurprisingly, given the promise of returns from 8% up to 20%-plus. The challenge now will be finding a decent supply of the right investment opportunities and delivering the expected level of performance.
Look out for a an extended feature on distressed debt investment in Asia in the coming Spring issue of AsianInvestor magazine, and further analysis of this in-demand asset class in our daily newsletter.