Despite a multi trillion-dollar funding gap, unfamiliarity with Asia continues to hold institutional investors back from private debt investments in the region, as some asset owners prefer tried-and-tested regions like the US and Western Europe.
Small and medium companies in Asia are facing a $4.1 trillion gap as banks pull back on lending in the region, according to the Alternative Credit Council. Investors have taken notice, with dry powder rising to $16.2 billion in 2019 – up from $6.1 billion a decade ago.
Some asset owners, however, are steering clear, at least for now, as they fix their eyes on more established private debt markets in the West.
For instance, AustralianSuper said that its private debt portfolio will focus on Australia, the US, and Western Europe for now because it did not know the lending frameworks in Asian markets like India and China.
“We don't know China or India, which are the two markets that make the most sense to look at just because of our size and the size of those markets… Some of the smaller countries, you sort of question whether you’re going to get the scale needed to make the size of investments that AustralianSuper is looking to make,” head of private credit Nick Ward told AsianInvestor.
Similarly, Nuveen, which manages $1.3 trillion, of which $270 billion belongs to its parent company; US-based Teachers’ Insurance and Annuity Association (TIAA), are still very much focused on US and Europe.
Of the $270 billion of TIAA’s assets that Nuveen manages, only $11 billion is invested into Asia Pacific, and a small fraction of that into private debt.
“How much of this proprietary capital and how much we've actually got allocated into debt programmes in Asia Pacific… is still very much at the early stages,” Simon England-Brammer, senior managing director for Hong Kong and head of Asia Pacific and Middle East, told AsianInvestor.
Real estate debt makes up a “large part of the business, at around $35 billion, and a good proportion of that of that is allocated to the US market.
“In Europe, it's far more focused on the UK market. So there, we're now into our third fund, and the direction of travel is likely that we will start looking at having more of a pan-European allocation to real estate debt,” he said.
However, he notes that there has been an increasing number of conversations about private debt with clients, and allocations are likely to increase in the future.
“When we think about risk-adjusted returns and the destination of capital, Asia Pacific is a maturing market when it comes to those asset classes. And certainly, from our perspective, we want to be investing more into that space [with] our own proprietary capital and third-party capital as well,” he said.
In Asia Pacific, “Australia and Japan are by far and away, the leading markets that we would focus on for obvious reasons. That said, when we look at the periphery, we will start looking at areas such as Greater China, Korea – so that sort of North Asian element,” he said.
Myron Zhu, head of private markets for Asia at Manulife Investment Management, noted that Asia private debt is “still rather nascent compared to its peers in the US and Europe” and that home bias could influence western investors to avoid the continent.
“Europe and US investors generally expect some risk premium for taking the additional Asia emerging market risks, and rightfully. For Asia investors with strong local knowledge, they tend to be more comfortable with the risks within their own markets in general.”
However, he believes that there will be opportunities for private debt to grow in Asia in the future “as the capital markets continue to develop and mature”.
“There are a lot of opportunities to fill the large funding gaps that local banks could not fulfil due to their tight risk controls that resulted from regulatory requirements – from senior loans, acquisition financing, to special situations, especially in the mid-market space,” he said.
While Asia Pacific does present higher risks, the region’s risk-adjusted returns prove more attractive than in the US and Europe, argued Michael Marquardt, who was chief operating officer at Zerobridge at the time of speaking to AsianInvestor.
“If you look at default rates on high yield as a proxy, default rates in high yield in the US are about 4%. In Asia, they're about 3%. In Europe, they're about 2.6%. So actually, from a default rate on high yield paper – and remember how your papers are unsecured so it's even more risky than private credit, because we'd only do fully secured – Asia is less risky historically than the US,” he said.
“When you look at loss given default rates, Asia is actually slightly higher than the US and Europe. But the time to get your money back in Asia is actually much quicker than the US and Europe. But also, using Moody's data for loss given default, the US loss given default rates are blowing out, at around 25%. But what's happening is these companies are lasting longer. And when the lender steps in to try and recover their monies, because you haven't had proper covenants, there's not much left."
In Europe, he acknowledged that the private debt market is less risky than Asia, “but at the same time, the returns are double” in Asia.
“So you're getting compensated for that little bit of risk. In fact, you're getting well overcompensated. When you peel back the data and you get that independent data from Moody's, it actually says you should be investing in Asia now on a risk and return perspective.”
Still, there are other risks to look out for, such as regulatory risks “given the developing nature of Asia markets,” Manulife IM’s Zhu said.
“This does require fund managers to be extremely sensitive towards the goals and directions that local regulators are aiming to achieve, and construct their portfolio exposure accordingly.”
“Various countries within Asia are at different stages of the development cycle and carry the respective associated risks. At the end of the day, deep fundamental research, right manager and partner selection with full alignment of interests coupled with portfolio diversification are the best tools to manage these risks,” Zhu said.
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