Asia tipped to pivot away from high-yield bonds

Asian investors are set to fuel “tremendous growth” in demand for loans as they diversify away from high-yield bonds, a private equity chief has predicted.

It comes amid a raft of refinancing deals, with Europe in particular seeing a resurgence of buyout activity this year.

Jeremy Ghose, CEO of 3i Debt Management, said that the firm was targeting family offices and private banks in the region but had already seen Asian pension funds and insurers "steadily increasing allocations" to the asset class.

London-based Ghose oversees almost $12 billion of loan investments, mostly in the form of CLOs (collateralised loan obligations). He argued that senior secured loans are superior to high-yield bonds because they had a floating rather than fixed rate, and were secured and not protected from being called, unlike high-yield bonds.

Being callable gives issuers the flexibility to refinance if their backers – such as PE firms – decide to put them up for sale or there is an opportunity to reissue at a lower yield.

“PE firms in general prefer to use senior secured loans,” said Ghose, citing the flexibility of being able to refinance without paying a penalty.

There is plenty of refinancing going on. “Corporate debt remains at one of the lowest levels in my 30 years of investing,” said Ghose. “Large corporates should be able to withstand significant economic shocks that come their way.”

“We have not experienced any defaults in our ‘version 2’ CLOs,” said Ghose, referring to CLOs adapted in the wake of regulatory changes introduced post-financial crisis.

Europe has seen a resurgence of buyout activity this year. In the second quarter of this year, buyout deal value rose 59% compared to the first quarter. North America and Asia witnessed 20% and 18% declines.

That may kickstart growth in European CLOs, which are presently dwarfed by the US market. US CLO issuance amounted to almost $125 billion of the $145 billion global total in 2014. That has seen Asian investors mainly invest in the US market to date, acknowledged Ghose.

Seeking to tap demand for European as well as US loans, the fund manager launched the 3i Global Floating Rate Income Fund on July 2.

The fund manager has already seen Asian interest for Australian dollar, Singapore dollar and Japanese yen tranches of the newly launched fund, said Ghose, who explained that the new fund would allow additional currency classes to be added.

“We look to generate an attractive and stable return” of around 4-5%, said Ghose.

“Europe is slowly but steadily following the US model. Over the next 3-5 years it will look more and more like the US model.”

The fund will primarily invest in senior secured floating rate corporate credit assets in both Europe and the US, and have some discretion to dynamically allocate between the two according to shifts in market conditions.

American AAA CLOs have yielded around Libor +150-160 basis points over the past six months, more than European AAA CLOs, which are “quite an anomaly in the market,” said Ghose. That is because European AAA CLOs have been yielding less than US triple-A CLOs since the European Central Bank embarked on quantitative easing earlier this year.

That has seen strong demand from European banks for AAA CLOs in the face of limited supply of AAA assets, observed Ghose. Lower-rated CLO tranches are being bought up by institutional investors which are combining triple-A and/or double-A CLO tranches with CLO equity. These so-called BBB-rated combination notes offer a 5-6% blended return compared to around 1% for plain vanilla BBB assets.

The fund was launched with $150 million AUM, with 3i Group committing $75 million at launch. It offers fortnightly liquidity and will report NAV daily.

Ghose claims that 3i has relationships with the world’s top 50 PE firms. Separately, he said 3i decided not to invest in the debt of PE deals that it has an equity stake in when Mizuho Investment Management was spun out of the Japanese bank in 2011 to form 3i Debt Management. Its assets under management have nearly doubled since then - when 3i Debt Management was formed in February 2011 its AUM was £4 billion ($6.4 billion), and Ghose said it was now almost $12 billion.