Year ahead: Korea's vote of confidence in private debt

Of all the investors in the Asian region, arguably the most enthusiastic when it comes to private debt are those from South Korea. And the message in 2017 is that they are looking at more of the same.

“I think private debt will be one of our major investment focuses next year. We have scheduled to add about $300 million to $400 million in this area, depending on market situations,” says Dong Hun Jang, chief investment officer of South Korea’s Public Official Benefit Association.

Amid the search for stability and cash yield, Korean investors are reallocating their investments from the traditional public fixed income bucket towards more private credit-oriented strategies. In 2016, Korean pension funds such as Korea Post Savings, Government Employees Pension Service and Korea Teachers’ Pension committed $100 million to $300 million to overseas private credit.

“We continue to see significant demand on the direct loan side, typically floating rate instruments like first lien, second lien and unitranche term loans where you continue to get the benefit from a rising interest rate environment,” says Andrew Schardt, head of private credit at Hamilton Lane.

“In particular, the mid-market lending opportunity will continue to be a big focus for Korean investors, because it is an area characterised by capital dislocation compared to the larger end of the debt markets. Mid-market businesses also tend to be less levered, and certain risk metrics, defaults and recovery rates are all more positive than in the larger end of the industry.”

Demand for particular strategies will vary depending on the risk and return appetite of a given investor.

“Korean insurance companies are passive and conservative, therefore they are very active in pursuing senior loans or mezzanine loans in aircraft deals,” says Philip Yoon, head of the global alternative investment team at the Korea Teachers’ Credit Union.

Bruno Le Saint, head of global finance for Asia-Pacific at Natixis, adds: “Institutional investors in Asia-Pacific are increasingly seeking the stability and long-term yield offered by alternative asset classes, with a particular appetite for infrastructure and aviation debt.”

Last year, South Korea’s KB Insurance and Natixis signed a $400 million agreement to co-invest in infrastructure and aviation debt deals globally.

However, some pension funds and credit unions are more wide-ranging in their choices. In 2016, POBA committed more than $640 million to private debt investments outside the real assets category. This included $120 million to private debt funds, $100 million to CLOs, $120 million to mezzanine debt and about $300 million to structured notes.

“In POBA, we pursue absolute returns over 5 percent, so we cannot invest in straight bonds like US treasuries or KTB bonds. This year, structured notes, CLOs, and private debt funds are our main focus areas,” says Jang.

At the Korea Teachers’ Credit Union, Yoon says CLO investment will continue to be a major focus over the next couple of years. “We will grow or at least hold the current level of investment in real estate mezzanine debt because it can generate quite satisfying yield at around 5-6 percent, whereas we think the return from real estate senior loans is lower than our expectation,” he says.

Meanwhile, Schardt says the mature and established US market will continue see demand from Korean investors. “And for Europe, the potential opportunity is significant, as banks’ balance sheets are much larger compared to their US counterparts, so at some point direct lending by non-bank institutions becomes more actionable. At the same time, we could finally see more opportunity as European banks divest distressed or NPL portfolios.”