Private debt markets are well placed to extend their boom for a second decade, especially if global interest rates and credit spreads stay relatively depressed, industry insiders say.
Private or alternative debt assets under management globally increased almost threefold to $200 billion in the 10 years to 2016, according to data provider Preqin. And some of the region’s largest investors, including Korea’s Public Officials Benefit Association, the Hong Kong Jockey Club, the New Zealand Superannuation Fund and Australia’s Cbus, have helped to extend that trend this year by significantly increasing their allocations to the asset class.
Pension funds and insurers account for roughly 50% of the investors in Asia engaged in private debt markets, Yang Mei-ni, principal at Mercer Private Markets in Hong Kong, told AsianInvestor. The remainder are foundations, endowments, family offices and sovereigns.
As bank lenders have retreated in the wake of the global financial crisis, forced by new rules—notably Basel III—to reduce their lending to sub-investment grade and middle-market corporate borrowers, so the opportunities for alternative lenders have grown.
“Traditional providers of that financing are changing as banks are more constrained and other investors like insurance companies and pension funds are filling that void. We’ve seen insurers who have been stuck at the investment grade level looking at being in the sub-investment grade level,” Linda Cunningham, head of debt investments at Melbourne-based super fund Cbus, told AsianInvestor.
Is the boom in private debt sustainable?
“There is undoubtedly a cyclical shift, driven by the low level of returns and potentially reduced downside protection that high-quality government and corporate bonds will offer over the medium term," Chris Redmond, global head of credit at Willis Towers Watson, based in London, told Asian Investor. "I am genuinely not sure whether this will extend beyond the current cyclical environment.”
However, if the current low-interest rate environment persists, Redmond added, this would encourage “an even more dramatic cyclical shift away from traditional fixed income”.
NZ Super currently has three private debt mandates with Canyon Partners (NZ$180 million), Bain Capital Credit (NZ$90 million) and American Securities (NZ$33 million).
Mercer’s Yang also believes that there is plenty of dry powder left and puts a number on it too: around $200 billion currently, mostly for North America and Europe.
In Asia, there is also a willingness among private debt investors to take on a little more risk than is the case elsewhere. While European alternative debt allocations are focused on the top of the capital structure, investor appetite in Asia is more focused on mezzanine and subordinated debt.
“It’s different in Asia because you would expect to get a higher return from the local equity market, if you assume the local market is going to give you 6-8%,” Redmond said. “Thus, when going illiquid and offshore, there’s probably a greater requirement for return.”
Redmond, ultimately, is optimistic about the sector: “The deepening and broadening of the private debt asset class is likely to represent an important driver of institutional asset owner allocation growth. This might push the average allocation from 3-5% closer to 10% over the next 5-10 years."