RBS and sister publication Private Funds CFO conducted a survey of private fund managers across the alternative asset spectrum, around 30 percent of which were private debt managers. The overwhelming majority (88 percent) of respondents expected their investor base from Asia, with the exception of the Middle East and China, to continue to grow.
Australia, which is generally lumped into the Asia-Pacific region, was a separate choice in the survey. Almost 44 percent of fund managers expected the number of investors from there to increase as well.
The private fund managers that were surveyed had a bullish view on the appetite for alternative assets. Debt firms have benefited particularly from South Korea’s robust interest in private credit.
Key to the growth of private debt in Asia will be performance in the next downturn. Although private credit has become an established part of institutional portfolios in North America and Europe, Asian investors are only in the early stages of incorporating the asset class into their portfolios.
Private credit, and particularly direct lending, has been pitched to LPs as an inherently safe alternative to private equity, because positions are higher in the capital structure and returns remain attractive compared with other fixed-income investments. This is well understood by North American LPs, which were the earliest adopters of the strategy.
Business development companies, a special type of US mid-market lending firm that gained traction in the run-up to the global financial crisis, were among these early adopters.
Apollo Investment Corporation generated $930 million in its initial public offering in 2004, turning heads and causing money managers to look closely at alternative lending vehicles. That amount was massive, even by today’s standards. A bevy of BDCs have gone public since the financial crisis, but many have generated proceeds in the $100 million-$150 million range.
Managers say the asset class was a difficult pitch to investors before the crisis because it was the black sheep of the investment world. LPs were unsure where to put it in their portfolio because it did not have the return profile of private equity, nor the liquidity of traditional fixed-income investments.
Now, LPs have created specific private debt allocations or reshaped their alternatives or fixed-income allocations to accommodate the asset class.
Most tellingly, private credit, according to PDI data, has raised $1.14 trillion from 2012 through the first half of this year. Let that sink in: private debt has raised more than $1 trillion post-GFC, a phenomenal figure by any standard, and particularly for such a young asset class.
However, if we ask the simple question of whether the asset class is a permanent fixture of LPs’ portfolios, people may come up with very different answers.
The 13-figure sum is a more than compelling reason to respond in the affirmative, but the answer is likely to be much more nuanced.
Whether the low-interest-rate environment will persist and whether the asset class’s performance will hold up through the next downturn will be big factors in determining the future of private credit.
On the interest rate question, there is no reason to think things will change in the near term, particularly after US Federal Reserve chairman Jerome Powell sent strong signs to Congress in recent testimony that the central bank could actually cut interest rates. However, the question of performance is up for debate.
Certainly, covenant-lite credit agreements are much more prevalent in the upper mid-market and the broadly syndicated space than they are elsewhere. Yet mid-market lenders have slowly started to budge on terms they did not think they would ever cede ground on.
Maybe the investments will perform well, though there is a real chance that Swiss-cheese covenants and expansive definitions of EBITDA will come back to haunt lenders. Managers continually assert that they have robust downside protection, but we will not know that until the downside scenario comes.
For those in the private credit space, signs point to the asset class being here to stay. But debt managers should not take investors’ favour for granted.