APAC institutions looking to raise private credit allocations
Asia-Pacific investors have a keen eye out for private market assets, a new survey by asset manager State Street shows, and investment opportunities in the region are looking promising as distress opens up for alternatives diversification.
Within private markets, private equity remains the most attractive asset class, with 69% of institutional investors in Asia-Pacific expecting to make it their largest allocation over the next two to three years – a higher proportion than globally (63%), the survey released on February 6 showed.
State Street
Still, private credit is more of a focus for Asia-Pacific institutional investors (50%), higher than investors in the US (43%), Europe (40%) and Latin America (33%), and for good reason, according to Eric Chng, State Street's Asia-Pacific head of the alternatives segment.
“Investors want more attractive returns when too many people are crowding up in the private equity space," Chng told AsianInvestor. "Then they look at how to get an edge when [the internal rate of return] for private equity is falling, so private credit becomes attractive as one of the alternatives.”
ALSO READ: Demand for private credit set to rise as PE valuations slump
GROWING MARKET
Established over the past 10-15 years in Asia, private credit is relatively new asset class in the region compared to the US and Europe. Its history in the US, in particular, is longer because of greater transparency and the depth of the market. Chng said private credit could be listed and traded very easily in the US.
Asian markets differ markedly, unlike the homogenous US market, and investors must take many jurisdictional considerations into account, but they are starting to display some common traits, especially the ability to access English common-law standards in places such as Singapore and Hong Kong.
Still, specialised skill sets are needed in each domestic market. Asia is a fragmented region and each country has a different set of governing lows and unique local requirements that makes portfolio construction challenging, Chng pointed out.
"Both India and China have large domestic markets that have become accessible to foreign investors. Governing laws and enforceability is critical for investor confidence either on a secured or unsecured basis,” he said.
ALSO READ: China and India emerging as key Asian private credit markets: CPP Investments
More specialised private debt general partners are focusing on India and China for a reason. It takes considerable effort to find deals and perform due diligence on deals in those jurisdictions, and investors are rewarding GPs with such specialist skills.
"Specialised GPs spend most of their time understanding the domestic markets, selecting the right deals and conducting extensive due diligence which gives them the ability to build a successful track record hence generating investor interest," Chng said, elaborating:
"These GP generates alpha with superior pricing power on deals taking advantage of the differential domestic currency versus US dollar funding rates; risk premia associated with a local governing law and counterparty relationships.”
DISTRESS DIVERSIFICATION
Reflecting a global pattern, the State Street survey found that 64% of respondents in Asia-Pacific plan to continue their allocations to private markets in line with current targets (68% do globally), despite acknowledging that interest rate rises have reduced the attractiveness of the highly leveraged asset class.
However, the anticipated distress that last year's turmoil, which included higher interest rates, brought means that asset owners are also looking for opportunities arising from an ongoing market shake-up.
In general, asset owners have been growing their alternatives allocation share of total assets under management as a part of their strategic asset allocations. Private equity remains the dominant strategy but valuations have come under stress against a backdrop of a rising rate environment. Fundraising has slowed considerably while the same goes for the number of exits, but portfolio company valuations still remain lofty, Chng pointed out.
ALSO READ: Singapore’s MAS gives private credit $1 billion stamp of approval
As limited partners, asset owners depend on distributions, meaning that older vintages will pay for new subscriptions, but the distribution percentage has been falling over the past two years.
“In real estate, for instance, redemptions are coming in at such a pace that even big GPs are putting limits on redemptions. It will get worse before it gets better,” Chng said.
“Since asset owners will continue to allocate to alternatives, they seek and see an opportunity to diversify in the distressed environment. That can provide a perfect hedge when asset owners can see vintage valuations go down while distressed players of the right pedigree will grow exponentially, so the portfolio diversification story remains intact.”
The State Street study surveyed 480 respondents among insurance companies, other asset owners, traditional asset manager and private market managers across North America, Latin America, Europe and Asia-Pacific.
The study was commissioned by State Street and conducted by CoreData Research from September to November last year.