The APAC Growth Story for Private Debt
APAC’s positive growth story – namely its sharp economic recovery from COVID-19 and rapidly emerging middle class - provides fertile ground for private debt in the region. Take the pandemic, for example. The COVID-19 pandemic has created many distressed debt opportunities at companies whose long-term business models are inherently strong but face short-term liquidity or cash-flow issues. The region has also been impacted by bank deleveraging as a result of Basel III capital requirements. Global banks are increasingly attempting to wind down their international lending portfolios, especially for SMEs (small to medium-sized enterprises) who will typically incur higher capital charges. According to the Alternative Credit Council (ACC), local APAC banks are also very prescriptive in terms of their lending requirements. A paper by the ACC said many domestic banks routinely insist that loans be linked to real estate collateral instead of cash flow, CapEx lending, or structured receivables financing, which is disadvantageous for SMEs seeking growth funding.
Together with the scaling back of COVID-19 induced government liquidity programmes, the significant drop off in bank lending creates an opening for private debt managers to capitalise on. In contrast to banks – which have either ceased lending altogether or made it prohibitively difficult for SME borrowers to take out loans – APAC private debt firms are likely to ramp up funding into these businesses. Unlike banks whose loans are frequently limited in nature, the scope of financing tools available through private debt managers is extensive, ranging from direct lending, mezzanine financing, sponsor lending, right through to distressed or special situations. However, the ACC added that the majority of Asian managers would typically pursue a special situations strategy or engage in what it described as opportunistic lending, such as debt re-financings or bridge financing . With credit strategies looking increasingly enticing from a return perspective, Broadridge has observed that hedge funds are increasingly launching private debt vehicles as they look to diversify their return streams and capture greater institutional investor wallet share.
Moving Into Private Debt Needs to be Carefully Considered
Strategy diversification brings a range of benefits. However, transitioning away from relatively liquid hedge fund strategies – offering investors monthly or quarterly redemption terms to private debt - which is illiquid and requires multi-year lock-ins, can be challenging. It is vital that managers procure flexible technology solutions to help them forecast their cash flows and conduct scenario analysis tests to manage liquidity risk properly. Although these incidents were not linked to private debt funds, a handful of asset managers running daily dealing strategies have been criticised over deficiencies in their liquidity risk management processes. Liquidity risk management is something market regulators and investors are taking seriously, so asset managers should take note.
It is a Buyers’ Market
Private debt may be attracting significant inflows from investors hoping to obtain countercyclical opportunities, but that should not lead to any complacency on the part of managers. Irrespective of whether a manager is running a private debt strategy or not, investors want detailed reporting and a thorough look-through of their underlying portfolio investments. Increasingly, institutional clients are demanding that detailed return metrics and analytics – replete with data visualisations – be provided to them in near real-time via their smart devices. Historically, many firms have supplied these metrics via PDFs or in physical form on a monthly or bi-monthly basis. Although previously acceptable, contemporary investors are now more accustomed to receiving this information through digital channels in a timely fashion. As such, firms need to either strengthen their internal operations – a process that can be very expensive and time-consuming, or leverage external technology companies with the scalability and expertise to help them meet clients’ digital requirements. Even though investor demand for private debt is growing, there is still competition for assets. Prospects will reject managers whose reporting processes are deemed to be inadequate.
The APAC Opportunity
As with the rest of the world, the private debt market in APAC offers a number of enticing opportunities, especially as government liquidity programmes come to an end and banks tighten up their lending. Although moving into strategies like private debt is appealing for many firms, it requires asset managers to invest in their systems and update their reporting processes. A failure to implement these basic operational improvements could make fundraising much more challenging.