China Taiping Insurance plans to increase its allocation to debt while trimming its equity holdings as global economic growth slows and the slowly tightening monetary conditions begin to bite.
“We will be increasing our exposure to debt strategies while scaling down investments in equities,” Wang Chenshan, vice president of the investment and asset management division of its subsidiary Taiping Investment Holdings, told AsianInvestor last week.
“There are two areas of focus in the coming year,” Wang said. “One is structured credit instruments, including collateralised loan obligations (CLOs), [which] will be our number one focus. The second will be private senior secured loans, though we will steer away from mezzanine or anything with a lower repayment priority.”
CLOs are single securities backed by pools of debt, often lowly rated corporate debt, which sprung to prominence during the 2008 global financial crisis (GFC) as sources of stress within the global financial system.
Taiping Investment Holdings handles third-party money and some of the investments, including the private debt allocation referred to by Wang, of its Chinese state-owned parent, which is listed in Hong Kong.
Wang said Taiping Investment Holdings handles up to 25% of the insurer’s alternative investments. It had Rmb54.7 billion ($8 billion) in assets under management as of the end of 2018.
Wang told AsianInvestor that the allocation to structured credit strategies in the investment manager's portfolio will increase to 55% while that of private debt (mainly direct lending) will rise to 15%. However, he did not provide figures for what this might mean in monetary terms, or where these allocations were set to rise from, or how the increases looked like at the parent level.
The insurer groups both private debt and structured credit under fixed income.
According to the Chinese insurer’s interim report for the six months ending June 30 2018, allocation to debt securities, debt products and other fixed income investments stood at 47.4%, 14.8% and 8.1%, respectively.
Wang said the insurer invests in both onshore (Chinese) and overseas markets.
Aside from its businesses in Hong Kong, the HK$724 billion insurance group –which celebrates its ninetieth birthday this year – has overseas arms covering businesses such as life insurance, general insurance, broking and finance and leasing in Australia, Singapore, Europe and the US.
Wang acknowledged the growing challenges to investing in debt. With a turn in the credit cycle underway in the US, he said he believes the price for private debt will likely drop as more recessionary conditions develop in the world’ biggest economy over the next 18 to 24 months.
As the operating environment becomes tougher and overall liquidity tightens, so defaults could rise, driving down the price of debt.
Other investors have voiced such concerns as well, including Paul Carrett, the group chief executive officer of Hong Kong-based FWD group, who identified the leveraged loans market as a potential pressure point.
It is at such times that the expertise of a private debt manager comes into sharp focus.
“It’s so important for investors to choose their managers wisely and understand what they are, because many of the direct lenders in the market today have never done direct lending before and have not seen the GFC,” Shawn Khazzam, head of the alternatives solutions group for the Asia-Pacific region at JP Morgan Asset Management, told AsianInvestor. “So you want to make sure your manager has the experience and you know what you own.”
In the face of potentially growing headwinds for private debt, Wang explained to AsianInvestor how Taiping Investment Holdings will cushion its portfolio by investing with the right managers and strategies.
“We expect to work with fund managers and ‘big names’ that have been through the previous global financial crisis in 2008 as we believe they have more bargaining power and will be more experienced in crisis management,” Wang said.
In addition to unlisted senior loans, Wang said he was interested in special situations and distressed debt opportunities and would likely seek out firms with experience in these fields when selecting foreign private debt managers.
In that respect, he is unlikely to be alone.
“The potential risk of a recession in the next few years also speaks to the need to have a range of private credit strategies — across performing, special situations and distressed — that can flourish in different environments,” JP Morgan Asset Management said in its 2019 Global Alternatives Outlook report this month.
Wang expects investments in private debt to yield 6% to 7% on a cash basis (before leverage) and an internal rate of return of about 8% to 10%. He also said that the usual time frame for such private investments ranges up to seven years.
In contrast, the investment arm of China Taiping Insurance plans to shrink its allocation to equities, including private equity, Wang said.
Wang didn’t provide any further details, but according to its interim report, the insurer had 5.6% of its investments in equity securities.
“If we were to invest in pre-IPO companies now, we will likely catch the economic downturn as we think that, after the recent rate hike, we are currently at the peak of the economic cycle. The stock market will probably come down and weigh on the valuations of the private market in the next six to 12 months,” Wang said.
Less clear is why investing instead in CLOs promises better prospects, given they are typically a repackaging of leveraged loans and other risky debts and will also be vulnerable in a downturn. But then that’s all the more reason for Taiping Investment Holdings to choose its fund managers wisely.
*This story has been updated with more recent AUM data for Taiping Investment Holdings.