The momentum in private credit is continuing to gather pace as investors fill the demand/supply gap in line with the potential returns available.
“In an income-starved world, Asian private credit provides attractive risk-adjusted returns with risk premia over and above the developed markets and conventional strategies in the liquid credit space,” said Celia Yan, head of China and co-portfolio manager of Apac private credit at Blackrock.
Fundamentally, investors worldwide are striving in the wake of the pandemic to diversify portfolios away from traditional 60/40, equity/bond allocations.
“We can see this happening in real time with the evolution of cryptocurrencies, and the growth of the hedge fund and wider alternative investment management industry,” said Craig Reeves, founder of Prestige Funds.
Within Asian private credit, diversification benefits stem from a global perspective as economic and credit cycles continue to diverge.
“Overall, with low competition between private lenders, yield premiums remain attractive and loans are heavily covenanted with high margins of safety through low starting loan-to-values,” added Yan.
Emerging credit plays
India and China are compelling when looking closer at Asia’s private credit potential, especially in relation to growth capital and stressed refinancing.
In India, the credit gap is broadening, with non-performing loans rising further in the banking system. “[This is] leading to scalable opportunities in performing private credit and distressed opportunities,” Yan explained.
In China, meanwhile, the focus on deleveraging and onshore defaults will create further gaps in the credit availability for small- and medium-enterprises, along with the real estate sector, she added.
Balancing risk and return
Alongside outperformance, risks are inevitable within this asset class. For example, Asian private credit ends to be more concentrated than a public credit strategy due to the opportunity set and ticket sizes.
At the same time, there is re-investment risk due to the possibility of early prepayments of principal on loans. Further, given the mix of underlying loans in both US dollars and local currencies, investors should weigh up potential currency risks.
Default risk is another factor to consider. However, said Yan, while there might be yield erosion in the case of defaults, she does not expect principal loss given low starting loan-to-values and strong covenants.
According to Reeves, operational risk is also a threat. “People, process and systems must be of a high standard.”
Protecting against this and other downside risks is a function of constant reviews and analysis. “Clearly, from the start of an investment approval, the asset allocation at credit committee and investment committee is important,” he explained. “But the ongoing monitoring of underlying customer and sector risk is also important.”
For Prestige, each investment approval has what Reeves describes as an “investment plan” – to look at how, when and where the investment can be exited. “This all comes back to the operational risk…. Experience counts for a lot, as does corporate memory,” he added.
At Blackrock, the Asian private credit team has what Yan calls “boots on the ground” in all the countries the firm is active in – to focus on understanding counterparty risk and promoter selection.
“The successful strategies are those that can tap this opportunity set through a strong local, onshore presence to understand the nuances of each market in Apac, and have the breadth and depth of expertise to understand how to structure and create tailored solutions,” she explained.
To find out more about the strategies that were covered at our Spotlight On: Alternatives, see links below.