Asia Forum: Relative value

As delegates gathered in Hong Kong for PDI’s Asian forum in November the macro-economic headwinds were blowing strongly from China, but those at the Harbour Grand hotel were looking at sunnier days ahead.

The illiquidity premium usually commands greater attention from direct lending managers, but it was the relative value on offer in Asia-Pacific that was on the mind of many delegates.

Private debt managers want access to bilateral term debt, although that is far from being achieved on a grand scale in Asia-Pacific. One attendee likened private debt in the region to a cottage industry, but the forum heard plenty of examples of international managers making ground on the multi-family offices and hedge funds usually performing niche lending in the space.

Here are some observations from the forum:

China is seen as an exciting opportunity, but a pan-Asia-Pacific strategy appears to be the current focus of many investors and managers, particularly given the recent Chinese stock market crash and fears of a rise in defaults, much of it related to real estate or anti-corruption drives. Eric Solberg, of EXS Capital, noted huge volumes of capital flowing out of the mainland into Japan, Australia, the US and Europe.

Despite this, there remains vast amounts of liquidity in China, which, along with increasing bank regulation, should create an interesting dynamic for the evolution of the region’s private debt in the years ahead.

Edwin Wong, managing director at SSG Capital Management, remarked that everyone wants to be in Asia. “Most of them are trying to break into more exciting markets,” he said before stressing: “It’s not easy. It’s really not easy.”

Helen Wong, founder and chief executive officer of LAPIS Global, also added a note of caution, remarking that when doing business in the region “you have to know your partner”.

To borrow an old Chinese phrase: “There are no principles, only relationships.”
There are also more risks to consider when choosing to invest in younger private debt markets, not least governmental or political.

As Helen added: fundamentals are more important when investing in private debt.

The lack of a safety net in the form of a robust legal framework may be worrying, but panellists argued that private debt in Asia offers better relative value compared with North America and Europe.

“[With] senior debt and performing credit, we generally see more conservative credit structures … certainly regulatory changes will provide an opportunity,” said Adam Wheeler, managing director at Babson Capital Management.

The US and Europe were more crowded spaces than Asia, but the region was seeing greater flexibility on offer on the private side compared with publically-traded markets.

Comparing spreads with Europe and North America, Robert Appleby, director at Asia Debt Management, said: “The spread between private and public has never been so great and Asia wins that footrace towards being the cheapest.”

Chris Mikosh, co-founder of Tor Investment Management, which extends bridge financing, believed that there was as much as 500-700 basis points available between their investments and similar risk in the US, while Stefan White, portfolio manager from LIM Advisors, added: “There are great deals floating around the developing markets. It’s just a matter of having the network.”

Investors with long-term lending ambitions, including Sankaty Advisors and Partners Group, were also at the conference. “There are a lot of opportunities that didn’t exist here a couple of years ago,” David Yu, senior vice-president at Sankaty, said. “There are good opportunities to work on capital relief trades.”

As in Europe, private debt in Asia-Pacific cannot be approached as a whole. Each individual jurisdiction carries its own risks, so when starting out it might make more sense for a private debt manager to focus on particular markets with lots of potential. Edwin Wong said that in more frontier areas it’s harder to build scale, so he would rather go deeper into a big market such as China or India.

In the event of non-payment it is precisely these markets where it can prove the hardest to recoup principal. One panellist recounted a saga which had been ongoing for 20 years.

Meanwhile, Religare, an India-focused private debt manager, demonstrates how the Asia-Pacific market is throwing up more domestic players. They are dwarfed by the number of private equity firms in the region – which could work in their favour.

Jake Williams, deputy group chief risk officer at Standard Chartered, said his bank would be aiming to shed roughly $50 billion in risk-weighted assets.

“I think there is a big opportunity here. Non-performing loans are rising and it will be a real opportunity if you know what you’re doing … and how business works here,” he said.

He feared a rush of capital from the US into the region, however, particularly the kind without a firm grasp of all the risks. There would be a lot of sellers, but an influx of buyers could hit the profitability of trades, he added.

Eric Marchand, senior vice-president at Unigestion, speaking to PDI after the conference, thought that Asian private debt could work particularly well within a private equity mandate.

“Private equity on average should deliver higher returns than private debt, but a marriage of the two could offer the best of both worlds if there is some uncertain macroeconomic times ahead,” he said.

Given the track record of some private equity firms in certain geographies, using a high-octane debt product over private equity might leave investors with a lower exit multiple, but a similar or even higher IRR, which on a risk-adjusted basis might be more relevant, he added.

“In a recession or following a significant macroeconomic adjustment, if you are investing at the bottom of the curve, investing with such structures could achieve the 25 percent IRR mark,” he said.