Korean asset owners target riskier private debt
Korean asset owners are looking for higher risk private debt strategies as they invest as limited partners (LPs) in fund vehicles, according to a new report by alternatives data provider Preqin.
After securing a stable portfolio of senior debt, allocators in the region are diversifying by investing in mezzanine, distressed and special situations funds, according to the 2024 Preqin Territory Guide on LPs in Korea.
“As tightening credit conditions increase the range and number of distressed opportunities, investors are also seeking greater exposure. Korean LPs are willing to take on slightly more risk in their private debt investments to achieve their return targets,” Harsha Narayan, AVP and senior writer at Preqin and lead author of the report, told AsianInvestor.
Direct lending, a staple of private debt, continues to attract strong investor interest, with the proportion of active investment plans in the strategy for the next 12 months growing to 56% in 2023, up from 49% the previous year, the report’s data showed.
However, some LPs have expressed concerns about the high weighting of direct lending funds in their portfolios and are looking for diversification within their private debt strategies.
One insurer told Preqin that “in order to rebalance (the portfolio), we may consider investing in large-cap private equity funds with a stable strategy next year, rather than just looking at private debt”.
“Investors need to weigh the benefit of higher spreads against the risk of economic downturn and defaults and how that might impact more junior debt positions. Higher-risk investments also require more thorough due diligence,” Narayan said.
“Investors must ensure that the funds or transactions they invest in have strong covenants and risk management standards to protect their investments.”
ATTRACTIVE RETURNS
Higher interest rates, while often a headwind for private equity, can represent an opportunity for private debt sectors.
“Institutions we spoke to have noted that returns on direct lending funds have risen to levels comparable to those of equity funds. With even senior debt funds offering higher yields than before, Korean LPs are increasingly shifting their attention to private debt funds,” Kim Hangyul, Preqin’s senior investors associate for Korea, said.
While concerns about further interest hikes may have eased, the consensus among allocators in Korea remains that it is premature to expect rates to fall as swiftly as they rose. Many of these organisations now believe the era of ultra-low interest rates has ended, with medium to high interest rates likely becoming the new normal.
These expectations have significantly steered the focus of LPs in Korea toward the private debt market. The proportion of LPs considering new investments in this asset class has grown from 26% in 2022 to 39% in 2023, while the proportion of those not committing here has decreased from 20% in 2022 to 16% in 2023.
As with its peers in Asia, Korean LPs continue to look at private debt favourably given its relatively stable return and low volatility profile, particularly amid a high interest rate environment.
South Korea is home to large asset owners such as the Korea Investment Corporation (KIC) and the National Pension Service (NPS), who have been early adopters of private debt. It has become an integral part of their long-term asset allocation strategy to help meet their raised investment targets.
“This has influenced other LPs in the country to include private debt as part of their portfolio diversification strategy. With these LPs now believing that medium to high interest rates are likely to become the new normal, many have steered their focus towards the private debt market rapidly,” Narayan said.
SPECIAL NEEDS
Korean asset owners have a strong presence in private markets, which has grown in the past five years. The number of active LPs in South Korea investing in private equity has increased with 150% while in private debt, real estate, and infrastructure, the figure has risen around 50%, Preqin data showed.
In a challenging fundraising environment, international managers are increasingly targeting Korea to raise capital from local LPs and diversify their investor base. However, this creates intensified competition for both local and international managers, who must now present compelling strategies to attract these domestic LPs.
Narayan pointed to some key areas that international managers could do to attract capital in Korea, such as understand the profile of specific Korean asset owners and the best way to reach them.
“Many of the investors use advisors and gatekeepers to help recommend funds so building relationships with these groups can be helpful. They could also consider approaching non-institutional investors such as family offices and HNWIs who may be much easier to access and more flexible in their investment decision-making process,” she said.
Given the Korean asset owners’ cautious nature, it would also help to have a strong track record or more experienced professionals on the management team to give the asset owners comfort. Asset managers should also be prepared for a long and thorough due diligence process,
“LPs in Korea tend to have a long selection process and managers need to be prepared for more detailed disclosure and reporting requirements as well as a lengthy due diligence process,” Narayan said.