Tokyo Forum: High Asian demand amid low yield

Korean investors in particular have aggressively shifted their allocations from fixed income security to private debt.

At a private debt workshop at the PEI Global Investor Forum in Tokyo, managers and investors came together to discuss the fundraising environment and opportunities in private debt. Despite being a relatively new asset class, private debt is expected to attract more long-term capital under the current low-yield environment.

Pensions in particular, which have a long time horizon and longer-term capital to invest, are highly attracted to private debt these days.

“These investors have taken the time to understand the product offering, they understand the illiquid nature of the product but also understand, if invested over a longer period of time through the cycle, it is an attractive asset class where you can achieve excess return,” said Michael Smith, partner and co-head of the Ares Credit Group

In the US market, Ares is seeing an aggressive movement from US insurers entering the private debt space. Asian investors are also beginning to look at the asset class based on risk appetite and their enthusiasm for investing in a senior debt space showing excess return.

“We can wait, as a long-term investor. If bad things happen, as time goes by, things will pick up. In that sense, the debt proportion is more comfortable for local Korean institutions,” said Dong Hun Jang, chief investment officer of Korean pension POBA. POBA is getting more conservative in relation to buyouts nowadays. Jang believes that private debt has a certain security even in the event of default and that the asset class has shown quite a substantial recovery rate over the past 10 years.

In addition, Korean institutional investors have been suffering from the low interest rate and are hungry for yield. Therefore, local institutional investors have diversified into alterative investment very aggressively. In particular, there has been a big shift from fixed income securities to private debt, according to Jang.

However, getting investors to fully understand the asset class can be a challenge. “It is a new asset class. If you talk to a pension fund about private equity, they understand what it is, they understand where the return is coming from. In credit, when you talk about generating low double-digit returns to high-teen returns, investors would be like, ‘how can you be generating that sort of return in credit? That’s what they don’t understand,” said David McWilliam, managing director of Bain Capital Credit.

Managers agree that private equity players are increasingly picky in choosing lenders for their companies.

“The reality is, sponsors are not necessarily looking for the cheapest form of capital or the most flexible form of capital, they are looking for capital providers that have certainty to deliver and capital providers that behave sensibly if something doesn’t go as planned,” pointed out McWilliam.

“It used to be the PE community didn’t really care who financed their businesses, they were looking for the cheapest form of capital and often that was the bank,” Smith reflected. However, this scenario changed after the financial crisis when Ares has found itself becoming a key counterparty for the PE community. He recalled having to sit down with many companies to lay out a plan for the next few years to take portfolio companies back to the stage where both the sponsors and the creditors could make money.

As markets becomes more heated, it plays into the hands of quality credit providers rather than newcomers because the former have been operating through cycles and counterparties have seen how they have behaved through the ups and downs.