Asia-Pacific Private Credit Newsletter
The first quarter of each year sees institutional investors rebalance and reinvest last year’s gains into more attractively valued or diversifying positions. 2021 begins with investor risk appetite at high levels, driven by hopes that vaccines and stimulus will lead to the recovery and normalisation of economic activity. This year, the challenge is finding opportunities which offer genuine value and diversification.
The latest risk monitoring research from BlackRock points to relatively high cross-asset correlations between almost all asset classes outside of developed government bonds. Yet there is little incentive to increase holdings at current yields. So how should investors obtain diversification without sacrificing returns?
A review of current advice from the investment community reveals three strategic trends that may meet this challenge:
Add to EM and Asian assets, which continue to be underinvested
Allocate from traditional fixed income to growth-oriented fixed income (GOFI)
Allocate from public to private markets
In this Newsletter, we examine these strategies and consider how Asian private debt might complement and enhance portfolio construction options.
Within a broad EM/Asia allocation
It is possible that we are at the beginning of a multi-year period of EM outperformance versus developed markets. Real GDP for emerging market and developing economies is expected to grow well ahead of major developed economies. Within EM, Asia is expected to grow 8.0%.
Given the levels of monetary and fiscal stimulus and reflationary expectations, asset allocator bullishness is to be expected. The December 2020 BAML Global Fund Manager Survey showed short USD and long EM asset positions, with the implication that a weaker dollar drives strong EM performance. A US-driven push on infrastructure may also support commodity prices, which is also an EM driver.
These are the orthodox pro-EM arguments, but the composition of public indices has changed dramatically since China entered global capital markets. For example, while the MSCI EM Index still covers 27 countries, constituent changes and capital flows have pushed concentration levels towards China, Korea and Taiwan.
THE SEARCH FOR VALUE AND DIVERSIFICATION
A decade or more on from “BRICS”, index performance is now dominated by large cap Asian tech companies. Allocation to EM is no longer an automatic diversifying play and the old relationships with developed markets may no longer hold. In our view, investors now need to drill into specific asset classes and strategies to construct the risk, return and diversification profile they are looking for.
The 2020 recovery rally has made investment-grade corporate bonds – the conventional source of credit risk –expensive. With reduced return expectations, institutional investors seeking yield or income are allocating more of their portfolios to "growth-oriented fixed income" (GOFI) – in effect a broad bucket that can include investments in EMD, high yield, convertibles, senior loans, and absolute return/multi-asset credit strategies.
This reach for yield has led many investors to Asian HY bonds. With healthy yields of 7%+, expected low default risk expectations and stable demand and supply, this growing asset class has clear attractions. Yet again investors face the issue of concentration. Using the Bloomberg Barclays Asia USD High Yield Diversified Credit Index as an example, there are significant concentrations in China and construction of which investors should take note.
Those who wish to approach credit in a way that tilts to preferred geographies but retains genuine borrower diversification should take a closer look at Asian private debt.
From public to private
We continue to see private market investments occupy an increasing share of institutional portfolios. Private equity has been in focus for the last few years but is struggling to meet investor expectations. There are several factors for this, including record levels of “dry powder” and scarcity of genuine opportunities and historically high valuations. Some strategists argue that private debt offers superior risk-adjusted returns for investors who wish to harvest the illiquidity premium.
Returns for APAC buyout/growth funds have held up better but a similar dynamic is observed with elevated prices, increased competition, and limited exit opportunities weighing on future returns. There has also been a concentration in China and tech-focused areas.
In contrast, Asian private debt is still an emerging asset class. The Burgiss Manager Universe (which sources exclusively from LPs – other databases show higher numbers) counts just 34 funds across Asia representing USD16bn in committed value since 1997 through June 2020.
Furthermore, the asset class can be an effective complement to existing Asian and global private equity programs. Corporate direct lending funds display far fewer “J-curve” characteristics to those found in other private closed-end funds - the investment pace is faster, thereby dampening the performance impact of organisational costs, and profit generation is immediate from current cash yield.
Conclusion – Asian Private Debt can play an important portfolio completion role
Particularly in Asia and EM, public debt and equity markets are not deep or necessarily representative of underlying economies – private markets are even more important in these regions. A private debt strategy with broad APAC exposure can be one of the components that provides a completion role, without sacrificing returns. Our current pipeline shows a broad spread of geographic and industry exposures and - as we discussed in our last Newsletter - APAC SMEs (95% of the region’s economic activity) are starved of capital.
With expected net IRRs of 12-14%, investors in Asian direct lending should be comfortably rewarded for the additional illiquidity and complexity, compared to EM equities or hard currency bonds. It may be time for investors to reconsider their EM/Asia allocation strategy, divert some capital away from the Alibabas and Tencents and towards SMEs that really need it.
The 2021 opportunity
As the world sees light at the end of the COVID tunnel, the private debt industry is looking back at its first real external shock since the GFC and positioning itself for the future. By most measures, the industry has shown reliance and investors continue to increase allocations to the asset class, especially in view of declining yields in traditional credit strategies.
The Asian private debt story has not been derailed. Though deployment slowed in 2020 as investors took time to fully analyse impacts on their existing portfolios and new investments prospects, 2021 is set to provide investment opportunities not seen in recent times, especially as vaccine programs roll out and travel becomes easier.
There are many factors that are contributing to this; the departure of many global banks’ balance sheets from the region and the low-risk appetites for new loans from the banks that remain in market is key, especially as we see end of formal and informal moratoria and many bank lenders deal with a significant rise in non-performing assets (which also need resolution). In a region that was already short of capital for lending, this has made the supply/demand imbalance more acute. COVID also reduced cross border M&A and investments significantly which are now beginning to pick up and are another driver of private credit volume.
As always, borrowers need time to adjust to new realities in funding options – many larger and higher credit quality borrowers who, before the current crisis, had alternative financing options in banks and broadly syndicated markets have already turned to private credit providers – this is accelerating as many companies run down cash surpluses.
All of this is leading to a large and growing pipeline for 2021 with deals across the spectrum from small to large companies, conservative leverage, more lender-friendly structures, and enhanced pricing.
The journey for Private Credit during the COVID crisis
Special Report: How Private Credit, Subject of Scary Forecasts, Came Out a Winner | Chief Investment Officer (ai-cio.com)
SWFs focusing on partnering with managers, a win-win
State funds see direct-lending partnerships as growth engine (pionline.com)
Global and regional banks retrenching, opportunity for Private Credit in Asia…
Credit funds eye openings as more banks cut Asia lending | Alternatives | AsianInvestor
JP Morgan’s perspective on Private Credit going forward
Private Credit Outlook | J.P. Morgan Asset Management
More banks pulling back, private credit funds and investors stepping in…
Exclusive: Rabobank to close London, Shanghai and Sydney trade finance operations | Global Trade Review (GTR) (gtreview.com)
QIC enters private debt, hires from AMP Capital | Financial Standard
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Zerobridge Partners Asset Management Limited is focused on giving institutional & high net worth investors globally access to APAC alternative credit opportunities. The strategy seeks to take advantage of the less developed banking and capital markets in the APAC region and capitalize on our strong proprietary deal flow.
Zerobridge Partners Advisory Limited is a debt advisory firm focusing on raising new capital, creditor negotiations and debt restructuring for companies in Asia-Pacific. We come with deep investment banking experience and a strong track record across multiple credit cycles in Asia.
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