Predicting the next decade: Asian LPs turn to private debt

All eyes are on Chinese pensions to see if they follow the lead of Korean and Japanese LPs

As home to some of the world’s largest pension funds, it’s no surprise that fund managers are targeting Asian investors. And with both Korean and Japanese LPs increasing allocations to private debt, hopes are high that the Asian market could provide growth opportunities for credit funds over the next decade.

“Asian investors are increasingly seeing the need to be in private credit, and the drivers are the same as elsewhere in the world: lower volatility, lower loss ratios, higher yields, better Sharpe ratios,” says Matthew Michelini, head of Asia-Pacific at Apollo Global Management. “Covid-19 showed that investors could work with borrowers in the private markets to avoid losses much better than they could in the public markets.”

LPs from Japan and Korea have been particularly active in the asset class. For example, the National Pension Service of Korea, the world’s third-largest pension fund, has been investing in US names for the better part of a decade.

“Korean LPs were one of the earliest investors in our global senior credit strategies, and Japanese LPs have been one of the largest holders within some of our semi-liquid strategies,” says Andrew Bellis, global head of private debt at Partners Group.

There is a strong sense that Chinese pension funds would like to participate in the asset class, too, but for now local investment rules make it hard for them to do so.

The current macroeconomic conditions are now accelerating the trend into private credit among Asian investors. “Our underlying private debt investments are floating-rate in nature, so that has a natural hedge against rising inflation and higher interest rates and, by natural extension, that translates into high returns for our clients,” says Zongwen Tan, a member of the management team in Asia for Partners Group. “In addition, given the higher rates, borrowers tend to be more conservative, and we are seeing better returns for lower leverage and tighter documentation.”

He adds, however, that some concern does remain about stepping into the asset class as inflation and interest rates are rising. He regularly receives questions about this.

“We think that this ultimately comes down to underwriting discipline and having in-house expertise to cope with unforeseen circumstances. This means that we need to invest with the notion that we may stay in assets for longer than expected, and would look to invest in assets which are resilient and benefit from long-term thematics,” says Tan.

Bellis says Partners Group has “recently made key strategic hires to enhance Japan and broader Asia coverage” in order to better cater to LPs in the region.

“Korean LPs were one of the earliest investors in our global senior credit strategies”

Andrew Bellis
Partners Group

Growing maturity

Most of the money that Asian institutions have been allocating to private credit has flowed to the US or European markets, with relatively little ending up back in Asia. But this may be starting to change.

“Asian investors built their private debt portfolios first in the US, then in Europe. Now some of them have mature enough programs and sophisticated enough departments to layer in some private debt from Asia,” says Rob Petty, co-head of the Asian division of Fiera Capital. “The same salesperson who is talking to Asian investors about a big name in US private debt will now also be talking to them about adding Asian private credit.”

The bias of Asian investors towards credit markets in the US and Europe is largely a reflection of the relative depth and sophistication of these markets, although Asia is now catching up.

“Private credit remains an under-penetrated asset class, especially in Asia,” says Raymond Chan, head of APAC credit for Canada Pension Plan Investment Board. “However, over the past few years, there has been an increase in appetite for private credit in the region, as more investors see potential alpha in the asset class… This is evidenced by more global and regional institutional investors dedicating resources and raising dedicated pools of capital to capture the opportunities.”

According to Ryan Chung, head of structured finance and principal investment at Huatai International, Asia-Pacific receives less than 10 percent of the money that is allocated globally to private credit – despite the region accounting for 40 percent of GDP (expected to rise to 50 percent by 2030). “There is huge potential for growth,” he says.

The Asian credit markets are starting to move beyond opportunistic bets, too. “If you look over the last five years or so, more than half the Asia-dedicated capital has been raised for distressed or special situation strategies,” says Brian Dillard, head of credit for Asia at KKR. “This is very different from where we see the biggest opportunities, which is on the performing side. These are investments in healthy, growing businesses which are market leaders, rather than as a lender of last resort or rescue financing.”

“Private credit remains an under-penetrated asset class, especially in Asia”

Raymond Chan
Canada Pension Plan Investment Board

Mid-market and higher

Michellini from Apollo says that there have been a number of “high-grade” deals in Japan recently, and similar opportunities are starting to emerge in Korea.

“Middle market or sub-investment grade lending is often the first step, but we see overall greater demand for the larger private investment grade market, and that is where we focus at Apollo,” he says.

As Asian private credit markets grow and become more established, more of the Asian money that is currently finding a home in the US or European markets is likely to shift back to the region.

“If you are an LP and you see a very active private debt market in your home country, and you’re seeing all these global opportunities as well, it just makes what is a relatively new asset class feel more familiar and more real,” says Shane Forster, head of Asia-Pacific Private Finance at Barings.

For now, though, many Asian LPs still tend to regard private credit as a fairly niche asset class, which is perhaps a reflection of their lack of familiarity with it as well as limitations in their investment mandates.

“There has certainly been a slower uptake in private credit among Asian investors than there has been seen in other jurisdictions. That is both at the investor level and on the regulatory side,” says Michellini from Apollo.

He adds that regulators and national governments have taken some time to embrace the benefits of private credit, but they are now getting there. For example, the administration of Japanese Prime Minister Fumio Kishida is incentivising more proactive management of assets in order to generate better yields, which may ultimately lead to a greater adoption of private credit strategies.

“There will be higher allocations to private credit among Asian investors – and I see this happening broadly across the risk-reward spectrum,” predicts Michellini.

The rise of Asian insurers

One of the earliest types of Asian investor to embrace the virtues of private credit were insurers, who found the asset class to be a very good match for their liabilities.

Many Asian insurers – Ping An and AIA among them – are among the most sophisticated institutional investors out there. “Insurers love credit and they understand credit. The asset class just makes sense when set against their liabilities. Insurance companies tend to be much more heavily-weighted towards credit than pension funds – and for good reason,” says Fiera Capital’s Rob Petty.

Brian Dillard from KKR regards Asian insurers as a “microcosm” of the global insurance market, so inevitably they are going to be extremely interested in private credit. “As in other parts of the world, we are seeing strong demand from Asian insurers for credit assets,” he says.

He adds that insurers are a bit more active on the direct lending side, rather than on subordinated credit, since “this tends to be a bit easier simply from a capital-charge perspective”.

There is another dynamic at play in Asia, too. Unlike in the more developed markets of the US or Europe, local currency-denominated long-duration assets in the region are in sparse supply. “This forces insurance companies [in the region] to be a bit more creative as they think through their fixed income allocations, and it opens up the opportunity set for private credit in a way that’s somewhat unique compared to other regions in the world,” says Dillard.