Are institutions losing interest in APAC private debt?
Despite steady recent growth, the private debt sector’s risk and complexity in Asia mean institutional investors are favouring more familiar markets in the US and Europe, according to a recent report.
“APAC returns do not sufficiently reflect an emerging market risk premium needed to entice wary European and North American investors away from well-known developed markets,” RJ Joshua, Preqin’s head of private debt, research insights in Singapore, and author of What is holding back private debt in APAC, told AsianInvestor.
The report was published on October 15.
FADING PROMISE
The report quoted figures from Preqin’s latest investor survey which showed the proportion of private debt investors judging Singapore to be the world’s most promising developed market fell from 9.5% in June 2021 to 0.5% in June 2024, even though total allocations to APAC grew over that time.
Those picking Australia and New Zealand fell from 9.5% to 2%.
At the heart of the problem is investors’ lack of confidence that the higher returns in APAC justify the higher risks of the sector here.
APAC focussed debt funds returned 14.2% between 2020 and 2023, compared with 10.4% globally.
In direct lending, the most popular subsector of private credit for global investors, APAC returns of 9.2% only just exceeded the 8.9% found in the US.
Investor concerns over the global economic health in the face of inflation and high interest rates, have seen them retreat from emerging sectors, particularly those in Asia, in favour of the more established, larger US private credit sector.
Those selecting emerging Asia as the most promising emerging market fell from 80% in June 2023 to 60% this year, according to Preqin’s investor survey.
By contrast, 89% of private debt investors in June selected the US as the world’s most promising developed market, up from 78% a year ago, and 60% in 2021.
bfinance
“It’s been a very strong period for private debt in US and Europe," Kathryn Saklatvala, head of investment content at bfinance, an investment consultancy in London, told AsianInvestor.
"Returns lifted nicely along with rates; spreads didn’t see much compression, and defaults remained low.
"So investors seeking private credit exposure have been able to find good opportunities in those relatively mature markets. We continue to see very low appetite for emerging market private debt, so yes, that does weigh against emerging Asia.”
RISK AND COMPLEXITY
“APAC private debt is skewed to the higher risk, higher return special situations and distressed strategies, compared to North America and Europe where direct lending is dominant,” said Joshua.
About 50% of APAC’s private credit market is devoted to special situations or distressed strategies, compared with a global average of 35%, according to Preqin.
Direct lending accounts for just 26% in APAC, compared with 49% worldwide.
As well as being riskier, many APAC private credit markets are more complex than those in Europe or North America, with loans collateralised with other companies in the same group, or in another jurisdiction, adding to the due diligence requirements of investors, Joshua said.
However, he noted that Japan, Australia, New Zealand, Singapore, Hong Kong and South Korea more closely resembled private credit markets in Europe and the US.
Andrew Thompson, head of private equity at KPMG Asia Pacific in Singapore, pointed to the challenges of credit analysis on lending to Asia’s large family firms firms in less mature markets, which often comprise multiple businesses across several sectors.
This imposes stiffer challenges on investors who have become comfortable with more established private credit markets.
“Investor have become good at making informed credit decisions and close analysis to lend against cashflows in the more sophisticated markets of Europe and the US,” he told AsianInvestor.
POTENTIAL
Despite these obstacles, many investors continue to persevere and grow allocations to private debt.
This is especially true of investors who are seeking to grow private market exposure.
“Among the big institutional investors, SWFs and pension funds, and family pension funds there is a lot of capital that needs a place to work. A lot of it starts with private equity then [graduates] to real estate and then to private credit,” said Thompson.
Major Asian institutions have increased allocations recently.
AsianInvestor in September reported that Income Insurance, Singapore’s fourth largest insurer allocated $778 million to the sector in 2023 and more than $1 billion in the 18 months to the end of June 2024.
Investors in recent years have been drawn towards filling the gaps in countries in Asia where domestic banks have limited lending – either retreating in the face of growing numbers of non-performing loans, such as in China’s real estate sector, or because they face stricter requirements around regulatory capital, such as in South Korea.
Thompson also pointed to the growth of Asia’s technology sectors, where companies typically have fewer hard assets to lend against, making them less appealing to banks.
India’s flourishing tech sector saw the proportion of institutional investors choosing it as the world’s most promising emerging market for private credit surge to 36.5% in June 2024 from 25% in June 2023, according to Preqin.