Asset owners eye distressed bets in alternatives
Elevated borrowing costs are leading Asia Pacific asset owners into private debt and secondaries while the equity side of alternatives is feeling the pinch of relatively higher interest rates, an institutional investors survey by State Street shows.
As increasing demand is seen for private debt and to some extent secondaries, this development comes down to dry powder, according to Eric Chng, global head of hedge commercialisation and head of alternative solutions for APAC and Middle East at State Street.
“Private credit is increasingly filling in the funding gaps that supports the valuations of the private equity segment in general. They do this with a nimbler approach as compared to traditional bank-led financing and can take a longer term view of their debt portfolios,” he told AsianInvestor.
Around two-thirds (65%) of Asia Pacific respondents in the survey agreed that elevated borrowing cost is a key challenge and will continue to negatively affect the attractiveness of leveraged private market investments.
Only 53% in Europe and 56% in North America believed so, the State Street survey “2024 Private Markets Outlook” showed.
BETTER VALUATIONS
With elevated borrowing costs, leveraged buyouts and highly leveraged companies will struggle as debt needs to be refinanced and the strength of their balance sheets will be a key focus.
“Companies that have pricing power to capture inflation adjustments will continue to be hedged as their ability to generate quality revenue streams ensures they have access to funding,” Chng said.
The leverage is not disappearing, but instead leverage is being diversified away with new pools of capital. This in turns supports the general private equity valuations that the market is seeing.
“Many large LPs are seeing the near-term valuations stress as an opportunity to acquire assets at better valuations. Hence the demand for private and secondary deals remains strong but the due diligence process is taking much longer as buyers try to get the best deal,” Chng said.
He observed that sellers are becoming more realistic, as the survey showed that 66% of Asia Pacific respondents believe that secondary sales will pick up as a means of freeing liquidity.
STICKY INFLATION
The faith in lower borrowing costs in Asia Pacific anytime soon are low as interest rate cuts are not the expected scenario.
Fewer than half (42%) of Asia Pacific respondents said they thought inflation had peaked in their region, compared to more than two thirds (68%) in North America and nearly three quarters (70%) in Europe.
The diversity of Asia Pacific economies creates a muddled picture with different countries facing varying levels of inflationary pressures. China, which is the largest economy, is continuing to slow down in terms of GDP growth, for instance.
“As the US dollar further strengthens with interest rates remaining high, economies dependent on trade will see inflationary pressures persists in the short to medium term, Chng said.
This is unlike the US trend where inflation is coming down to more controllable levels, although still above the 2% Fed target rate, and in Europe where the major economies are showing signs of inflation easing.
Private equity remains one of the favoured asset classes, the survey showed. However, distributions have been falling as valuations continue to fall, Chng pointed out.
“LPs are therefore increasingly focused on track record and favouring large GPs with specialist areas for deployment. The demand for transparency and look through data is becoming central amongst the many heightened due diligence requirements,” he said.
LIQUIDITY MANAGEMENT
The survey did indeed show that private debt is the most appealing alternative assets for Asia Pacific investors over the next one to two years, with 78% planning to increase allocation to the asset class. That is higher than the overall 71% average globally.
“Liquidity management will increasingly become a key focus area for strategic asset owners. As the levels of distribution remains depressed, the traditional dependence on distributions to fund new commitments will become a challenge,” Chng said.
According to State Street research, average distributions has been falling from December 2021 and remains depressed.
The study, commissioned by State Street and conducted by CoreData Research, surveyed 480 respondents from traditional asset managers, private market managers, insurance companies and asset owners across four regions, North America, Latin America, Europe and Asia Pacific. 120 of the survey respondents are based in the Asia Pacific.