AsianInvester
Advertisement

Private debt promises better gains for asset owners in low-yield environment

Asset owners from Korea to Australia see both better returns and inflation hedging when spreading their fixed income to private credit. Still, rising inflation and interest rates are forces to be reckoned with when choosing the right strategy for the asset class.
Private debt promises better gains for asset owners in low-yield environment

Allocation to private debt, or private credit, has emerged as a popular diversification strategy for asset owners in recent years, given its potential for higher risk-adjusted returns in a low yield environment.

Recently, private debt has also shown potential in dampening the damage caused by inflation on portfolio performance, via public market exposure. In the US, very volatile market conditions have emerged, with some of the highest inflation levels in roughly 40 years — combined with some of the fastest upward moving interest rates in 25 years.

Byungkyu Cheon

For life insurers such as Korea’s DGB Life Insurance, fixed income is the backbone of the investment portfolio. While it remains so, private debt investments hold potential that is hard to ignore, according to DGG Life CIO Byungkyu Cheon.

“From a regulatory perspective, we still have a lot of liquid fixed income assets such as treasuries, government bonds, and high-grade corporate bonds. However, from a return perspective we need to increase private credit investment that can enhance our portfolio return at the cost of liquidities,” Cheon said on May 26 at the Asian Investment Summit hosted by AsianInvestor.

He elaborated that DGB Life has nearly 3% of its $7 billion portfolio invested in private credit. Compared to its Korean peers, this is relatively low, understating the attractiveness of private credit amongst life insurers.

A POPULAR CHOICE

In Australia, the Queensland Investment Corporation (QIC), an investment company owned by the Queensland state government, is also seeing more interest in private debt from its limited partners, Queensland state clients, and other Australian institutional clients.

Phil Miall

As a result, QIC had in the last 18 months established private debt as a standalone asset class within its business, according to Phil Miall, head of multi sector private debt at QIC.

“The clients have a strong appetite for private debt. It gives them a natural hedge for inflation with the floating rate nature of the loans, but also from a regulatory standpoint we have had reforms for the future and super funds that came into effect last year,” Miall said at the Asian Investment Summit.

For private debt, the reform means the super funds are now able to include private debt into their fixed interest space. The super funds are subjected to close monitoring via a test of annual performance by the regulator Australian Prudential Regulation Authority.

“Private debt can and will help super funds outperform over that rolling eight-year time frame that they are measured on,” Miall said.

According to DGB Life’s Cheon, increasing the allocation to private debt allows less volatility in terms of valuation. In recent months, the markets have seen high volatility in all asset classes, including fixed income.

In case of private investments, asset owners can avoid some volatility from the capital markets, Cheon pointed out. At the same time, private debt also provides relatively higher return compared to the general fixed income investments.

“Our current fixed income portfolio has been earning just around 3%, including government and corporate bonds. But our private debt portfolio gave us a return of 7-8%. So, we sacrifice some liquidity, but we gain more than 300 basis points extra return which is helping our overall portfolio performance,” Cheon said.

UPS AND DOWNS

The volatility in recent months has thrown up challenges and headwinds, with inflation following Covid disruption. Meanwhile, central banks have been raising interest rates — as opposed to what happened just after the global financial crisis.

Taylor Boswell

In the US, the most developed market for private debt, asset management firm Carlyle Group sees the senior lending market as relatively well-positioned for the current situation, with rising inflation combined with high inflation, according to Taylor Boswell, Carlyle’s chief investment officer for direct lending. Still, it is more important than ever these days to check on the fundamentals.

“We are keeping a very close eye on corporate earnings, direct impacts of inflation, potential consumer retrenchment, and increasing interest burdens on companies. It is a solid picture for senior lending, I think we are sleeping relatively well compared to other asset classes but there’s a lot to talk about for sure,” Boswell said at the Asia Investment Summit.

¬ Haymarket Media Limited. All rights reserved.
Advertisement