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Private credit fastest growing alternative asset class among asset owners

Real estate and private equity are the most common alternatives that institutional investors allocate to, but private credit is fast closing the gap, according to a recent survey by Nuveen.
Private credit fastest growing alternative asset class among asset owners

As asset owners fret over extreme market events and inflation concerns, a growing number are investing in private credit and will continue to do so over the next two years, according to the second annual EQuilibrium Global Institutional Study by Nuveen.

The study, which surveyed 700 investors with at least $500 million in assets, found that 72% own private credit, up from 62% last year, the largest year-on-year increase of all alternatives.

In addition, 31% of those surveyed said they planned to increase allocation to private credit over the next two years.

Asset owners' current and planned allocations to alternatives
Source: EQuilibrium Global Institutional Study

Globally, two-thirds (66%) of the investors said they were more concerned now than two years ago about extreme market events and their effects on investment strategies, and 64% said they need to completely re-consider portfolio construction.

READ ALSO: How GIC incorporates uncertainty into portfolio construction

INFLATION WOES

Asia Pacific asset owners were more likely to implement inflation mitigation changes in their portfolios, and were particularly concerned about climate risks, the study published on Thursday (March 24) found.

“An environment of low yet rising interest rates and high inflation can make middle-market loans, infrastructure debt, real estate debt and other forms of private credit particularly attractive,” Michael Perry, head of Nuveen’s global client group said in a statement.

Stephen Hull, Zerobridge

The findings are in line with observations by private credit investors in Asia Pacific. Stephen Hull, partner at Zerobridge told AsianInvestor that even with the recent interest rate hikes, with more to come this year, it is unlikely yields will return to the levels of the 80s and 90s.

READ ALSO: Market Views: How will Asia’s capital markets react to rising interest rates?

“The progression of US monetary policy offers US dollar-based fixed income investors a choice of unpleasant scenarios. If the Fed and other central banks don’t do enough to dampen inflation – and most are constrained by the size of their own balance sheets - real yields will continue to get crushed. If the Fed responds more aggressively than anticipated, the result will be capital losses for bonds, especially those with lower coupons and/or longer tenors,” he said.

“These risks make large swathes of the public bond market uninvestable in pure return terms. Debt investors seeking real returns will need to look to private market solutions,” he said.

Private credit is particularly appealing to longer-term investors that can trade liquidity for higher returns, he added.

“Private credit, funded from public fixed income, potentially offers stronger covenants and better downside mitigation than public market equivalents. On a whole portfolio level, the ability to access higher returns from debt is diversifying and takes some of the 'heavy lifting' away from equity or growth assets,” he said.

SLOW APAC GROWTH

Despite the growing amount of dry powder for private credit in Asia - $16.2 billion in 2019, up from $6.1 billion 10 years prior – investors have been slow to find deals in the region, but considering the relatively high internal rate of return, Hull remains optimistic.

“Speaking to respected US-based placement agents, some see emerging markets and Apac-based strategies gain interest over the US and Europe but this is yet to be backed with hard dollars,” he said, adding that the region still accounts for less than 10% of global private credit AUM.

“Our strategy combines Apac direct lending and opportunistic investing and so we would include ourselves in that category. Apac offers higher IRRs (15+% gross, unlevered) than US or European direct lending. With similar default, loss given default and recovery rates to other regions, APAC investors are arguably well-compensated in risk-reward terms for the additional complexity of the region.”

“Deals tend to be shorter tenor and – unlike the US and Europe – there is not the problem of too much capital chasing too few deals, so Apac covenants and structuring tend to be stronger and most deals are not private equity sponsor-backed,” he said.

¬ Haymarket Media Limited. All rights reserved.
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