Riding the growth wave of Asian private debt

At a Glance:

• The private debt market has witnessed a significant growth with total private markets assets under management (AUM) reaching $11.7 trillion as of June 30, 2022, largely driven by long-term lenders like pension funds and wealth managers seeking higher yields.
• There has been a notable shift of global and regional investors towards the Asia Pacific's private debt market, which saw a 325% increase in total assets from US$20 billion in 2012 to $85 billion by July 2022.
• The comparative analysis of private debt markets in Asian countries and Australia reveals that Australia's mature financial sector and robust regulatory framework stand in contrast to Asia's dynamic, emerging landscapes, which offer a higher-risk scenario for private debt investors.

The private debt sector has recently made industry headlines, such as Reuter’s ‘Asia's private credit markets thrive as desperate borrowers find lenders’.

This article underscores the boom in the private credit market as long-term lenders, such as pension funds and wealth managers, seek to secure lucrative yields while meeting the needs of borrowers unsatisfied by public markets.

But is this a sustainable opportunity for investors or just a fleeting trend hyped by the media? What's the current situation of the Asian private debt market and what can we foresee for the medium and long term?

Let’s find out.

Private debt: A global growth story

Private debt refers to loans that are typically made by a non-bank lender, as opposed to a bank or public markets. Companies typically access private debt to finance growth, expand their working capital, or fund real estate development.

This form of financing is gaining traction for its ability to offer attractive yields and lower correlation to traditional asset classes. Over the last decade, private debt has grown exponentially, with total private markets assets under management (AUM) reaching $11.7 trillion as of June 30, 2022.

In fact, according to Pitchbook, the industry’s AUM could grow to $16.1 trillion by 2027.

What’s driving the private debt boom?

There’s a myriad of factors behind the surge in private debt. These include the perpetual search for higher yields in a low-interest-rate environment, regulatory shifts post-2008 that have created a substantial funding gap, and the allure of portfolio diversification due to private debt's lower correlation with traditional asset classes.

Private debt has also grown exponentially due to increasing interest from institutional investors, technological advancements facilitating easier access to private debt opportunities, robust economic growth driving capital demand, and an increase in acceptance among investors.

US and Europe are setting sails toward Asian shores

Both global and regional investors are turning their attention towards Asia Pacific's private debt market, especially as it recovers from the Covid-19 pandemic.

This pivot mirrors a global trend where traditional bank lending has been challenged, prompting a rise in alternative financing.

Driven by favourable interest rates and the promise of high returns, US and Europe funds have started to earmark significant portions of their portfolio for Asian private debt. From 2012 up to July 2022, total assets in the Asian private debt market swelled from US$20 billion to $85 billion.

That’s a 325% surge over the last decade and institutional investors will likely keep fueling growth, according to Sumit Bhandari, lead portfolio manager for Asia private credit at Allianz Global Investors.

Institutional investors are capitalising on the region's demand for infrastructure investment, estimated to hit $26 trillion by 2030. This is fostering a growing range of product offerings from general partners alongside rising interest from insurance companies.

Why is everyone veering to Asia?

Several factors are driving investors towards the appealing horizon of Asian private credit:

1. Significant and growing market opportunity. Unlike more saturated markets, Asia's private credit sector is yet to be fully explored, promising a significant market opportunity as the region's economies continue to mature and the demand for credit from private entities escalates.
2. Geographic diversification and exposure to Asian growth. Investing in Asian private credit allows for geographic diversification, reducing concentration risk for investors. Moreover, it provides an entry point to benefit from Asia's dynamic economic growth and favourable demographic trends, enhancing the potential for attractive long-term returns.
3. High economic growth and strong demographics. Asia is the world's fastest-growing economic region, with over two-thirds of global growth originating there. This robust growth trajectory is supported by a large, young, and increasingly skilled population, coupled with rising intra-regional trade, thereby necessitating substantial capital to finance the region's burgeoning business sector.
4. Increasing burden on banks due to regulatory change. Compliance with Basel III/IV requirements has raised the operational costs for Asian banks, making traditional bank funding less accessible for many businesses. This scenario creates a vacuum which private credit lenders are well-positioned to fill, offering an alternative source of capital.
5. Large funding gap for Asian middle-market companies. The bank market's pivot towards larger relationships has left a funding void for Asian middle-market companies, which constitute over 96% of all businesses in the region. In this scenario, private credit lenders can step in to provide the crucial capital these businesses need to reach their strategic objectives and grow.
6. Borrower demand for creative financing solutions. Asian borrowers are showing an increasing appetite for private credit due to its flexibility over traditional financing sources. Private credit provides more lenient terms and conditions, like principal repayment upon maturity, certainty, and speed of execution, while also reducing equity or control dilution compared to equity financing.

Asia's private debt landscape

Asia, as per OECD classification, is an emerging market rife with complexity for investors. Each country has its own jurisdictions, economic indicators, and market behaviours that make generalisation difficult.

In addition to the varied legal and regulatory frameworks, distinct cultural nuances render the charting of the Asian private debt seas an endeavour for expert navigators.

Here are some of the factors to consider:

• Corporate Landscape. The region boasts a vibrant corporate arena, albeit dominated by private networks. These tight-knit networks could pose entry barriers, while also creating a healthy ecosystem for private lending.
• Regulatory Diversity. The disparate regulatory frameworks across Asian countries significantly affect the evolution and operation of private debt markets. Some countries have nurturing frameworks for private debt growth, compared to others with more restrictive regulations.
• Tailored Investment Strategies. Given Asia's unique market dynamics, investment strategies in its private debt market need a tailored approach. The different economic development stages, types of industries, and company sizes across countries call for a nuanced approach to private debt investing.

Japan: a blank canvas for private debt

Japan's private debt market is almost non-existent, largely due to the economy's inclination towards traditional bank financing. The longstanding relationships between banks and businesses have overshadowed the emergence of alternative financing models. However, there's a potential for gradual change as the demand for diversified funding sources grows.

Korea: a limited but developing market

Unlike Japan, Korea shows signs of developing a more diverse private debt market, although it is still in its infancy. The regulatory environment is gradually becoming conducive for private debt, and there's a growing recognition of the benefits associated with alternative lending.

China: a market of scale and scope

China's private debt market is relatively more developed with a broad range of private debt instruments available. The sheer scale of China's economy and the government's push towards financial market liberalisation have contributed to the growth of private debt. Yet, the market is not without challenges, including regulatory hurdles and competition from traditional banks.

India: an emerging hub for private debt

The private debt market in India is gaining traction, driven by an expanding SME sector and a growing appetite for alternative investment among institutional investors. Regulatory reforms aimed at easing investment in private debt are further propelling the market forward.

ASEAN region: a blend of opportunities

The ASEAN region, with its diverse economies, presents a blend of opportunities and challenges for private debt investors. The market is gradually opening up, with countries like Singapore and Indonesia showing promising growth in private debt.

Australia: A promising market

Venturing south we find an even more promising private debt market, Australia. In contrast with the dynamic, multi-jurisdictional, and often less regulated financial landscapes observed across various Asian countries, Australia has a robust regulatory framework, coupled with a mature and diversified corporate sector.

Due to its maturity and stability, the sector is experiencing tremendous growth. From 2020 to 2021, Australian private debt Assets Under Management (AUM) more than tripled, and by the end of 2022, they reached $2.1 billion.

Let’s take a deep dive into the specific opportunities currently available in the Australian market.

Beyond development finance

In Australia, the allure of development finance has often been overshadowed by the inherent challenges it presents. The sector, primarily engaged in funding real estate development and infrastructure projects, is burdened by stringent regulatory hurdles and lengthy approval processes. The high-risk profile associated with development finance, coupled with the prolonged duration required to realise returns, make it a less enticing avenue for investors.

The real opportunity: the corporate sector

The real treasure trove in Australia's private debt market lies in two other opportunities that offer more immediate and often predictable returns compared to development finance.

• Non-Sponsored Lending. This form of investing involves lending to businesses without the support of private equity sponsors. The appeal of non-sponsored lending lies in its potential to offer attractive yields coupled with a level of security, especially in a market like Australia where the legal framework is robust and the business environment is stable.
• Specialty Finance. Specialty finance encompasses a range of financial services including asset-backed lending, invoice financing, and other niche financial products. The demand for such tailored financial solutions is on the rise, driven by the evolving needs of businesses and the desire for more flexible financing options.

Despite the recent growth, the Australian private credit market is still relatively young when compared to the US and European markets.

With only 9% of business lenders, the lucky country’s private debt market has ample room for growth in the short to medium term.

Risks and returns: Australia vs Asia

Asia and Australia have different private debt markets, each with its own set of risks and returns. These differences come from their unique economic situations and rules governing the markets.

Regulatory framework

Australia's regulatory environment, honed over decades of financial market evolution, offers a level of predictability and security to investors. The Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) provide robust oversight, contributing to a stable private debt market that potentially offers lower risks and consistent returns.

In contrast, the multi-jurisdictional nature of Asia's private debt market, with varying degrees of regulatory maturity across countries, presents a more complex risk profile. The diversity in legal frameworks and economic conditions across Asian countries can lead to fluctuating returns, influenced by local market dynamics and regulatory changes.

Economic stability

Australia's economic stability, underpinned by a mature financial sector and a well-established corporate sector, provides a conducive environment for private debt investments. On the flip side, the dynamic and emerging economic landscapes in many Asian countries contribute to a higher-risk, potentially higher-reward scenario for private debt investors.

Market maturity

Australia's private debt market, with established lending practices and a history of stable returns, contrasts with the nascent and rapidly evolving private debt markets in many Asian countries. This dichotomy reflects in the risk-return profiles, with Australia offering a more stable, albeit possibly lower-yield environment, while Asia presents a landscape of higher potential returns, accompanied by elevated risks.

These fundamental differences underscore the contrasting risk-return profiles of private debt investments in Asia and Australia, offering investors a diverse spectrum of opportunities based on their risk tolerance and return expectations.

Conclusion

Private debt offers a compelling investment opportunity, especially in the dynamically evolving markets of Asia. Beyond the headlines, Australia presents itself as a distinct but extremely viable avenue for those looking to diversify their portfolios.

In particular, senior secure debt and specialty finance in Australia offer higher risk-adjusted returns, making it an attractive market to consider for your next investment.

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