Asia private credit lures global investors amid risk concerns
Asia’s private credit market is gaining popularity among global institutional investors, lured by the potential for steady long-term returns and ample room for growth in size, even as concerns mount over risks in the asset class globally.
"It's natural for regulators to worry when an asset class grows quickly and is more opaque than public markets," said Eddie Ong, deputy chief investment officer and managing director of private investments at SeaTown Holdings International.
"For Asia private credit, with its customised deal structures, assessment must look beyond simple leverage or debt service coverage ratios. Downside protection mechanisms and third-party guarantees are crucial in determining creditworthiness," he told AsianInvestor.
Singapore-based SeaTown is owned by Temasek’s asset management group Seviora and specialised in alternative investment.
It is seeing an increasing interest in a performing Asian private credit strategy from global investors who have traditionally deployed in developed market credit strategies.
They think private credit in Asia has sustained headroom for growth, Ong noted.
“In the Asia-Pacific market, we see private credit delivering steady mid-teens returns to investors over the longer term. This is considerably higher vis-à-vis the long-term returns of public equities or bonds”, he said.
“Given that Asia private credit AUM (assets under management) is less than $100 billion, we believe there is significant growth potential,” he added.
The private credit market, where specialised non-bank financial institutions lend to corporate borrowers, reached $2.1 trillion globally in assets and committed capital in 2023. Approximately three-quarters of this market is in the United States, where its market share is approaching that of syndicated loans and high-yield bonds, according to data from the International Monetary Fund (IMF).
Asian asset owners have increasingly ventured into private credit strategies globally, including in the region. Several have highlighted the allure to AsianInvestor over the past year, including HSBC Life, the Indonesia Investment Authority, and CPP Investments.
As Asian investors’ interest grows, Asia’s private credit market is also expanding.
RISING RISKS
However, as the high-rate environment continues to weigh on corporate balance sheets and investor leverage costs, the market is on alert for rising risks.
The IMF identified four systematic risks with the instrument while acknowledging its economic benefits in its April report.
It highlighted higher borrower vulnerability to rising rates, increased competition leading to weaker standards, valuation issues due to infrequent trading, and significant interconnectedness with potential hidden leverage and rising redemption risks.
Michael Jones, managing director at PGIM Private Capital warned that the growth in the number of managers and the size of funds for established managers has driven down spreads and terms due to the need to deploy capital in a subdued mergers and acquisitions (M&A) environment.
Many managers have not yet been cycle-tested as most have been established following the global financial crisis, he noted.
"These newer funds will need to spend more time and resources on managing their portfolios or dealing with challenged situations involving businesses with capital structures that were established during the low rate environment," he told AsianInvestor.
Jones thought private credit should remain an attractive asset class, yet lenders need to maintain a disciplined structuring with protective terms. This would allow them to renegotiate or secure additional support when businesses underperform, minimising asset stripping risk.
For private credit investors, the trade-off is still taking illiquidity risk to receive higher yields and structural protections.
“One needs to bear in mind that there is not a substantial or liquid secondary trading market for private credit, particularly middle market companies”, noted Jones.
FOCUS ON QUALITY
Fiona Hagdrup, head of leveraged finance fund management, M&G Investments believes that it helps investors to manage private credit risk by not relying on rapid M&A to gain expertise or scale, but instead taking a bottom-up investment approach, focusing on quality and strong relationships.
This helps ensure a thorough understanding of investments and maintaining stability through market cycles, she noted.
“Companies most exposed to risks in the private credit space will be those with vulnerable business models, weaker defensive moats, and company management unproven across market cycles”, Hagdrup told AsianInvestor.
M&G Investments is looking at opportunities in Europe where they believe investors will likely benefit from higher returns with less risk compared to the US.
It favours European countries with a high concentration of mid-cap companies relative to their population. Additionally, it prioritises nations with established legal frameworks, particularly strong contractual rights.
“This preference underscores the protective attributes of senior and secured market segments. As a result, we focus on the UK, Sweden, Germany, and the Netherlands,” shared Hagdrup.
This article has been updated in the 16th and 17th paragraphs for clarification purposes.