Asset owners on the hunt for niche alternatives

Asian asset owners have growing asset piles and a need to source returns. And with mainstream investments looking peaky, their search for yield is taking them into some niche investment areas.

As AsianInvestor’s AI300 yearly study shows, the assets under management of the top 300 investors in Asia hit a record high of $36.78 trillion this year, versus $35.5 trillion in 2016. The need to profitably invest this money has led asset owners to consider investments they would have previously deemed either too niche or too hard to understand.

That includes private debt products, forestry and farmland, insurance-linked securities and infrastructure financing.

“Historically there has been bias towards private equity and more traditional real estate investing as the favoured kind of alternatives to diversify from public equity, but that is beginning to change,” Chris Redmond, global head of credit and diversifying strategies at investment consultancy Willis Towers Watson, told AsianInvestor.

With public debt returns unlikely to improve rapidly, interest in alternative alternatives is set to gain traction.

Looking far afield

There are several reasons why less mainstream investments could match the needs of asset owners. First is longevity. Asset owners such as pension funds, insurance companies and sovereign wealth funds often think of returns over decades. They have strategic asset allocations that naturally target longer-term investments. And alternatives, by their nature, tend to be illiquid investments that need to be kept for years before they can be divested.

Additionally, investors now need more variety, having already put more assets to work in traditional alternatives, namely private equity, real estate or hedge funds (even if the latter has lost its appeal due to weak returns).

Private equity and real estate funds in particular have been inundated with money in recent years.

“We are seeing a maturation of the industry where there are many LPs (limited partners) and too many fund managers, and they are often short of internal staff to keep track of all funds, so they want [to] give money to high conviction managers and get close to them and do co-investments,” the Asia-based chief investment officer of a pension fund told AsianInvestor.

This is causing the leading firms to have more capital. That means they can bid more against each other, inflating costs and, consequently, eroding returns. Whereas private equity funds in 2012 offered a median internal rate of return (IRR) of 14.2%, in 2014 it dropped to 9.5%, according to alternatives research provider Preqin, using its most recent full-year data.

Meanwhile, institutional investors that have less established relations with top private equity players are finding it hard to break into those relationships, or allocate as much capital to them as they would like. Some are therefore more willing to consider investments in newer areas.

Delving deeper into debt

The biggest and potentially most promising area is private debt—a catchall term for a wide variety of fixed income assets. As with public debt, private debt combines the relative certainty of receiving payment over a defined period with well-tested legal procedures in the event of default. So it naturally appeals to asset owners.

Better still, loans have to be repaid before bonds if a company goes bankrupt, so they are less risky too.

Interest is beginning to grow among Asian asset owners. “We’ve not [had] great moves but so far [asset owners] are looking into private debt, and they see some ways to hedge the risks they see in public fixed income,” said Adeline Tan, head of investment advisory for Hong Kong at Mercer.

 “We have seen growing interest and probably more activity in the private debt space,” agreed Redmond. “It’s a very broad church [of products] but this trend has taken hold in Asia. While the investment community is behind [that of Europe and the US] in adopting it we have seen pickup more recently.”

The possibilities in the private debt space are myriad, including areas such as mid-market loan portfolios from banks, securitisation products, infrastructure debt, trade finance receivables and more. “There is a huge variety in the securitisation world; 30 to 50 different components,” Redmond said. 

That variety offers asset owners many options and risk perimeters. For those willing to do the work and understand private debt, it offers a large new potential avenue of investment. 

Look out for part two of this series of stories about niche alternatives investing in the coming days, in which AsianInvestor speaks to various asset owners to gain their perspectives.