With too much money chasing the mid-market loans market and pushing down yields, Australian superannuation fund Sunsuper is turning to more specialised segments of the lending market to generate higher returns from its alternative assets.
“We've moved into some niche areas that are more capital-constrained because there's too much money going into mid-market direct lending, where yields are low, leverage is high, and covenants are weak,” Bruce Tomlinson, Sunsuper’s hedge funds and alternative strategies portfolio manager, told AsianInvestor earlier this month.
As a result, the superannuation fund’s allocation to vanilla mid-market loans within the hedge funds and alternative strategies portfolio has halved from its peak of 5%, Tomlinson said.
Around 6% of the A$60 billion ($43 billion) fund's portfolio is invested in alts and hedge fund strategies.
The challenge with direct lending in the middle market is that it can generate only four to five percentage points over cash, which is not enough of a risk premium, Tomlinson said.
He said he would rather take risk in more niche areas to generate a higher return of up to 8%.
Instead, the fund has been investing in more specialised parts of the market, such as private credit, stressed and distressed debt, and structured and asset backed credit.
However, he noted that these kinds of investments are tougher for investors as executing these deals can take longer and are likely to be more expensive, but the trade-off is that investors are rewarded with an illiquidity premium.
Niche credit investing targets investments in markets or regions that are too small to have access to capital markets or syndicated loan markets.
Investors can generally gain better control of collateral and push for stronger covenants, while lowering the extent of leverage required, through such deals.
In general, the Brisbane-based superannuation fund’s hedge funds and alternative strategies portfolio now consists of a higher share of credit strategies, including private credit, special situation credit and distressed credit and co-investments, in addition to trading-oriented hedge funds, said Tomlinson.
However, he did not provide a figure for the share of such credit strategies in the alts portfolio.
Sunsuper is not alone in searching for attractive credit opportunities: MetLife Asia has said it is looking to increase allocations to private bonds and commercial mortgages, which offer wider spreads than equivalent ordinary bonds, as well as better credit protection through stronger covenants.
Higher return expectations also prompted Korea’s Public Officials Benefit Association (Poba) to invest $50 million into distressed debt in 2017 via specialist manager Alcentra, while the Hong Kong Jockey Club, the New Zealand Superannuation Fund, and Australia’s Construction and Building Unions Superannuation (Cbus) have either ventured into private debt or increased their allocations over the past year.
Meanwhile, new capital rules across Asia’s life insurance industry have prompted insurers to turn to quasi-matching assets such as real estate and infrastructure debt that enables structuring cash flows to appropriate liabilities, a January survey by Invesco said.
The globally diversified alternatives allocation of Sunsuper also contains Asian assets, which are more weighted towards credit, private equity and hedge funds rather than real assets such as property and infrastructure, added Tomlinson.
The fund has traditionally invested in the more developed markets of the Asia Pacific, such as Japan, Singapore, Hong Kong, and Australia, but is increasingly investing in markets such as China, through offshore debt issued by corporates, he said.
But despite the opportunities that Asian markets offer, Sunsuper has struggled to put money to work.
“Obviously the emerging consumer economies is a great story, but the reality is investing capital at good risk-adjusted returns hasn’t been that easy,” Tomlinson said.
Bruce Tomlinson will be speaking at AsianInvestor's 10th Southeast Asia Institutional Investment Forum, which will take place in Singapore on December 5 and 6. For more information about either attending or supporting this event, please click here.