Why Western instos are wary of Asian distressed debt
Asset managers are increasingly building capabilities, obtaining licences and raising funds to invest in distressed assets in Asia, but they may yet struggle to attract much capital from outside the region.
Despite the growing opportunities in Asia, seen most notably in China and India, such strategies may still not be compelling enough for some Western asset owners.
“Investors are not knocking on our door saying they want to invest in Asian special situations or distressed debt,” Richard von Gusovius, global head of private debt at Campbell Lutyens, a London-based placement agent and advisory firm, said.
So any Asia strategies will probably have to rely on local support, he told AsianInvestor.
Global investors are still wary about investing in Asia distressed and special situations – relatively esoteric, higher-risk debt strategies – so such markets may be less competitive, particularly versus the US and Europe, agreed a debt specialist at one Asia-Pacific sovereign wealth fund on condition of anonymity
There are a number of possible reasons for this, on top of the difficulties of getting to grips with these relatively tricky specialist strategies in a region where legal certainty is often harder to come by.
For one thing, international asset owners tend to see more distressed opportunities and more general partners (GPs) with decent track records in this area in the West – particularly the US.
CURRENCY CONCERNS
Western asset owners tend to look to Asia for growth, not distress, the head of Asia investments at a North American pension fund told AsianInvestor. “You can still find good distressed opportunities in the US and Europe, so why come to Asia or emerging markets with the higher currency risk?”
Consequently, he said, “We have difficulty justifying an allocation to Asian distress.”
The added foreign exchange risk is also a factor for European investors in private debt.
European investors moving into the asset class to replace liquid credit in their portfolios are mostly pension schemes and insurers seeking euro or sterling risk in view of their local liabilities, von Gusovius said.
“When they come into the market, driven by [the] low-interest-rate environment to replace, for example, high-yield assets or other parts of their liquid credit allocation, the last thing they want to do is take currency risk," he added. "Especially now, when it’s particularly expensive to hedge back from US dollars. This can cost some European LPs up to 300bps right now.”
The cost for foreign investors to insure against FX fluctuations is reported to be near record highs, with the dollar strong and US rates high compared with Europe and Japan. That said, the US Federal Reserve's recent dovish turn will have taken some of the heat off.
That said, the currency risk issue could arguably favour riskier debt plays. Hedging costs are the same for a senior first-lien secured strategy earning say a net 6% as they are for a mezzanine or special situation investment yielding 15%, von Gusovius noted.
“It is easier to swallow those costs on the higher-return assets,” he said.
BLENDING OF ASSET TYPES
Another potential obstacle for limited partners targeting distressed or special situations assets in Asia is that relative newcomers to private debt in the region include various asset types in one vehicle, the US pension executive said.
“So there’s a direct lending element, there’s distressed debt, there’s secondary trading of depressed bonds, etcetera, all mixed in one strategy.”
This can be useful for the fund manager to “test the water” but it also makes it harder for investors to commit capital. After all, he added, it is already a challenge allocating to dedicated Asia vehicles for either direct lending or special situations.
It can be tricky categorising these assets. Distressed and special situations may well be included in the private equity allocation and looked after by that team.
That is the case with the above-mentioned North American pension fund , said its Asia investment head, partly because of the return profile of such assets.
GLOBAL MANAGERS FAVOURED?
Where large international investors do invest in Asian distressed or special situation strategies, some favour large Western GPs.
“Our preference is to go for global managers where we can, as we see value in being able to move [our] exposure as opportunities evolve,” the Asian SWF executive said.
“A problem with more regionally focused firms is the scalability issue,” he added. “There are not a lot of regional players with a lengthy track record who can take our desired scale.”
That said, some well established homegrown managers, such as Hong Kong-based firms PAG and SSG Capital, do raise decent-sized funds, including commitments from outside the region.
Indeed, certain big European insurers have now built out their European private debt exposure, so might back Asia-focused special situations or distressed strategies, von Gusovius said, declining to give names.
Germany’s Allianz, for one, committed $200 million to the Edelweiss India Special Assets Fund II, which closed at $1.3 billion in January.
An in-depth feature on the growing focus on distressed and special situations investments in Asia Pacific appears in the latest (Spring 2019) issue of AsianInvestor magazine.