Pension funds in South Korea and, increasingly, China are seeking to invest in the riskier portions of private debt assets.
Fund managers in the asset class say this appetite for increased yield stands in stark contrast to the once-burned, twice-shy attitude on display among asset owners in Japan.
“Korean investors are the most broadly-based investors in the region, in that there are investors [active across the risk spectrum,] from AAA [rated debt tranches] to mezzanine to equity,” said Oliver Wriedt, the co-chief executive of CIFC. His company is a US relative value credit manager, with $13 billion of corporate loan-based assets under management.
As previously reported, Asia-Pacific investors already constitute a large segment of the global private credit investor market. Wriedt told AsianInvestor this was the case at his institution too, with Asian institutions accounting for 16% of the assets under management that CIFC has received from external investors.
Institutions including Korea’s Public Officials Benefit Association (Poba), the Hong Kong Jockey Club, the New Zealand Superannuation Fund and Australia’s Cbus have each ventured into private debt or increased their allocations over the past year.
According to local Korean media reports just this week, Poba committed a further $150 million to three US funds investing in secured loans to US middle-market, private equity-backed companies. Out of this total, it will commit $70 million to credit manager Antares Capital and $40 million each to Ares Management and Golub Capital.
The Korean pension fund, which had an AUM of nearly W11 trillion ($10.3 billion) in late 2017, is targeting an annual return of 7% to 9% from these private debt funds over a period of seven to nine years, the media reports said. That is comfortably above its annual investment target of 5%.
Like CIFC, Golub has been particularly busy in Korea, raising over $100 million for its new fund, the latest closing of which was in January. This includes commitments from the Scientists and Engineers Mutual-Aid Association and brokerage firm Shinhan Investment, as well as from Poba.
Jang Dong-Hun, chief investment officer at Poba, said the fund’s rationale for investing into private debt funds was their ability to rapidly generate distributable income in comparison with private equity funds.
“We really do not like to go through the J-curve effect (where a period of initially negative returns is followed by a gradual recovery over an extended period), so private debt is a way to overcome this effect,” Jang told AsianInvestor.
Other funds look set to follow the likes of CIFC and Golub into Korea, given the ongoing appetite of institutional investors there to diversify their portfolios in the hunt for yield.
Contrasting risk appetites
The private credit market is a broad space and includes niche types of debt such as securitisations or bonds that use other debt, such as loans or mortgages, as collateral. It also encompasses high-quality investments all the way down to highly speculative tranches of debt.
It's a fast growing asset space. Alternatives research provider Preqin noted that the private debt industry stood at $638 billion in June 2017, triple the size of a decade before. And during 2017 a record 136 private debt funds were launched, securing a total of $107 billion—up from 163 funds raising $97 billion in 2016.
In Asia, Korean and Chinese investors have been particularly interested in putting money to work in riskier areas of the market.
“In China we are finding appetite mainly in equity- and mezzanine-type instruments, and also a significant interest in direct loan investing in the syndicated Term Loan B market,” Wriedt said.
Term Loan Bs are lent by institutional investors and are typically floating rate types of debt, with six-to-seven-year maturities and relatively few covenants. They also require small amounts of the principal to be paid back each quarter.
Yield-starved institutions in both South Korea and China are increasingly being attracted by the returns on offer from sub-investment grade tranches. By moving into BB or even B-rated debt tranches, investors can expect to get annual returns of 7% to 10%.
“That’s a very [appealing] comparable pick-up compared to emerging market debt instruments or high yield bonds,” Wriedt said.
Fund operators also noted that the vehicles are diversified across industries and individual borrowers, which should help to mitigate the extra risks. Wriedt said his company's bank loans funds generally hold assets of 100 to 125 unique borrowers, and the collateralised loan obligation (CLO) funds hold upwards of 250 borrowers.
While low-ranked tranches are popular in Korea and China, Japanese investors tend to prefer investing in the AAA ranked tranches of CLOs. But even here they are relatively constrained due to some painful recent experiences, having invested in private debt more than a decade ago, before the 2008 global financial crisis, and been left holding tranches that subsequently collapsed in value.
“Japan was probably the one market where we saw the most forced selling in 2009 [after the crisis emerged]," Wriedt said.
That ended up being a poor decision and it continues to colour the view of Japanese asset owners nearly a decade later.
“They made a risk decision to exit a lot of these exposures in 2008 and early 2009 … selling into the lows in the market," Wriedt said. "Based on the losses suffered, the Japanese market's appetite hasn’t returned.”