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Asia’s wealthy seek out private credit

As public markets have struggled this year, private banks have responded by onboarding more private credit strategies in response to demand.
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With volatility in public markets fuelling demand for alternatives, more and more private banks are onboarding private credit strategies and family offices are launching new products to tap the increasing demand among Asia’s wealthy for private debt.

Alternatives, ranging from hedge funds to private markets, has been one of the few asset classes that has held up this year as equities and fixed income funds have sold off in response to rising interest rates and geopolitical tensions.

Among alternatives, private credit, which encompasses everything from direct corporate lending to leveraged loans, has proved to be particularly popular with investors as they have sought out the more stable, predictable cash flows that they get from the regular interest and principal repayments associated with private debt.

While private credit has traditionally been associated more with the larger institutional investors, market observers say that it is increasingly becoming a staple of ultra high net worth and family office portfolios, which has prompted private banks and family offices to dedicate more resources to covering the asset class.

“This is very much a multi-year phenomenon. It’s not something that has happened just this year. When we think about family office money, generally we categorise it as smart money so family offices have been thinking about inflation and diversifying into other asset classes like private credit for quite some time now” said Kwan Chi Man, CEO of Raffles Family Office.

“Having said that, if you look at how the fixed income market has performed this year, you are getting 4%-5% in coupon but you are losing out in pricing. So in that sense, private credit, where you don’t have to mark-to-market and you are not subject to the same redemption pressures, is looking increasingly appealing right now.”

Pick-up in demand

Private credit primarily comprises three buckets. The first, and generally the largest bucket, is leveraged buyout financing. This has been growing in recent years due to the sheer amount of dry powder that private equity giants like KKR and Blackstone have raised, necessitating more private debt to finance their leveraged buyouts.

The second bucket comprises trade finance loans, which tend to be denominated in US dollars and are extended to mid-sized and large companies. These typically see the borrower pledge receivables or provide some form of working capital account in exchange for the loan.

The final bucket comprises corporate lending, particularly to small- and medium-sized borrowers. This has also been growing significantly in recent years, primarily since Basel III and other capital adequacy rules have forced banks to pull back from extending credit, particularly to smaller companies.

Private banks have different investment approaches, although a number of them told FSA that they would only tend to onboard strategies focused on developed markets, particularly in the US, because of concerns around enforceability and also currency depreciation if the underlying loans are denominated in currencies other than US dollars.

According to market observers, the fact that private credit is illiquid and therefore not subject to the current redemption pressures is the main reason why it has proved particularly attractive to investors this year.

“Let’s say you’re an ultra high net worth individual with three or four private bank accounts. Those accounts are down 30% or 40% depending on your concentration over the last 12 or 18 months,” said one private banker at a pure-play firm.

“Let me put some money in private credit. I know that it will be locked up for a little bit but the fund might distribute 8% or 9% per year so I should be able to make back the money I lost over the next three, four or five years.”

Here to stay

In addition to the fact that investors do not need to mark-to-market regularly, there are three other reasons why private credit strategies have proved so popular. Firstly, the returns that investors are able to generate are much higher than in the public markets even when controlling for mark-to-market losses.

It is difficult to put a figure on what the returns are for most private credit funds as these tend to vary widely depending on the types of underlying loans, although Adam Wheeler, co-head of Barings’ global private finance group, noted that the asset class generally comes with a premium of 2%-3% over the liquid credit markets.

The second reason is their stable, long-term cash flows make them appealing during the current period of volatility. Private credit, for example, compares quite favourably with private equity at the moment given that the current unfavourable market conditions make exits for private equity investments much harder.

The final reason is that when structured properly private credit is a defensive asset class. Typically, most loans will be backed by some form of collateral, often real estate, so investors should be able to enforce the security in the event of distress.

The asset class’ popularity has prompted both family offices and private banks to add more resources. In 2020, Raffles Family Office, for example, launched a dedicated division, its advanced wealth solutions division, which covers private assets as well as structured products.

Last year, HSBC said its private bank raised $3.2bn for alternative investments compared with $2.3bn the previous year. Most of the inflows came from Asia, HSBC said, and a large proportion of the flows were directed towards private credit.

Most of the public data appears to support the fact that it is a growing asset class. According to research from McKinsey, private debt is the only asset class to grow its fundraising every year since 2011 including in 2020 when the Covid-19 pandemic first hit.

According to research from WealthBriefingAsia as well, more than three-quarters of wealth management professionals in Asia Pacific have seen an increase in demand for private credit investment opportunities.

“While private credit will likely have its own set of hiccoughs going forward, when you think about it as a whole, it has only been around in Asia for 20 years. There’s tremendous room to grow further even if market conditions change,” said the private banker.

Part of the Mark Allen Group.