Institutional investors are turning to private debt in greater numbers in Asia amid the ongoing hunt for yield.
With more Asian central banks cutting interest rates in recent months, allocations to such non-traditional fixed income products have become more attractive, with private debt markets offering higher yields than publicly-traded debt.
In addition, direct lending has been taking a bigger share of private debt globally.
Since last year there has been a succession of interest rate cuts by central banks across Asia, including China, Thailand, India, Korea and Australia. The cuts have been made in response to slowing growth, as the central banks attempt to stimulate their economies.
The resulting lower yields appear to have had an impact on investors’ need for non-traditional assets.
In its inaugural 2015 global private debt report, data provider Preqin observed that fundraising for direct lending strategies increased fourfold from $7.1 billion raised in 2012 to $29.1 billion in 2014.
A February 2015 survey of investment consultants conducted by Preqin found that – globally – direct lending was seen as presenting the most attractive private debt opportunities (by 62% of respondents) followed by real estate debt (48%), distressed debt (45%), infrastructure debt (28%) and mezzanine debt (24%).
Overall, 57% of investors surveyed by Preqin in February said they intended to increase their allocation to private debt over the next 12 months.
“A lot of private equity firms are thinking about starting a direct lending business – with leverage, you can generate private equity-like returns,” observed Joseph Chang, principal for global private markets at Mercer.
One company active in the direct lending space has been Hong Kong-based SSG Capital Management, which raised $915 million for its third fund last year, almost double the combined size of the asset manager’s previous two funds.
Banks in countries like India and China are “incapable of funding a lot of corporates,” said Edwin Wong, CIO of SSG. “Structural inefficiencies force companies to borrow from non-banks – this will remain the case for the foreseeable future,” he said.
Non-banks are financial intermediaries which do not rely on deposits as their source of funding for loans. This means that they have a higher cost of capital than banks and charge borrowers a higher interest rate than banks do.
By the foreseeable future, Wong referred to the next ten years or more. The potential to earn a higher return on private loans over a long time period is luring investors to bid aggressively on deals in order to build up their Asia business.
The recent A$8.2 billion sale of GE Capital’s Australia and New Zealand consumer lending business – announced on March 15 but subject to “multiple regulatory approvals” according to a KKR spokesman – attracted bids from a number of international and domestic players, for example.
It has been reported that bidders included private equity firm TPG, Singaporean sovereign wealth fund GIC, non-bank lender Pepper Australia and Macquarie; and the A$8.2 billion price tag is A$1.2 billion more than the expected A$7 billion value of the loan portfolio. The winning bidders – a consortium including KKR, Värde Partners and Deutsche Bank – plan to repackage those loans and sell them onto third party investors.
Building up a private debt business is becoming more important for PE firms. Michael Forestner, Mercer’s CIO for private markets, observed that “the trend towards derisking portfolios on the pension side is reducing demand for private equity”, referring to US pension funds in particular. Instead of investing in PE, pension funds are focusing more on private debt.
“Asia’s private debt market is still a relatively small piece of the combined private equity/private markets landscape,” said Chang. “It is attracting some interest and becoming more common in selected markets like China or South-east Asia, especially for SMEs,” he added, referring to private debt.
Still, investors tend to look more to Asia for alpha. This means that equity remains more appealing than debt for many, said Chang.