Asia Pacific Credit: Finding the Sweet Spot

Asia Pacific is one of the world’s largest and fastest-growing regions. Despite representing two-thirds of global growth in gross domestic product, the region’s financing markets are relatively immature and still dominated by commercial banks.

Banks account for about 80% of the market (Exhibit 1) and typically have conservative lending standards that limit the type of capital they can provide for businesses. Other sources of capital, such as public debt and equity markets, are usually only available to large corporates and subject to market volatility.

Asia Pacific private credit only makes up a small portion of global assets under management and represents 0.1% of financing activity in a region with increasing demand. Therefore, we believe investors with local knowledge and deep experience can access a vast and attractive opportunity set within the performing private credit and public credit market space.

EXHIBIT 1: Banks Account for Primary Financing Mechanism in Asia Pacific

Looking Forward to a Decade of Compelling Investment Opportunities

At a macro level, Asia Pacific enjoys some of the strongest global macro tailwinds, including favorable demographics, a growing middle class, industrialisation, and the energy transition. Structural reforms are also making certain markets more investor-friendly, notably India. At the micro level, the region is heterogenous, so we believe investors should seek broad exposure to the region’s diverse countries and sectors to find the best relative value investments.

As market-leading, high-quality businesses across the region continue to grow, they have increasingly complex funding needs. Investors with flexible capital across private and public debt can find attractive opportunities providing bespoke solutions, such as bridging liquidity or valuation gaps, funding growth, or supporting business transformations. These are generally situations where banks are unable or unwilling to lend, and equity is often too expensive.

We think the opportunities in Asia Pacific credit are varied and exciting but investing in a diverse and complex region is not straightforward. We believe investors should look for four components when considering such strategies:

• A strong local platform for sourcing deals, corporate/promoter selection, and credit underwriting,

• Dedicated, scaled, and flexible capital,

• Disciplined risk management,

• Credit structuring knowledge and the ability to navigate local regimes.

Private Credit Is Poised for Significant Growth

Asia Pacific’s private equity market is large and maturing; however, the region’s growth in private debt assets under management has lagged. With Asia Pacific private equity dry powder at all-time highs, there will be greater need for private capital solutions to support deals in the near-term. Moreover, sponsors are becoming more accepting of institutional debt, particularly in Australia, India, and Southeast Asia. As of 2023, institutional debt represented 47% of all financing activity, compared with just 7% in 2020 (Exhibit 2).

EXHIBIT 2: The Rise of Institutional Debt in Asia Pacific

Asia-Pacific (ex-Japan) Sponsor Leveraged Finance Market ($bn)

Another potential catalyst for private debt is the impending maturity wall in Asia Pacific’s high yield bond markets over the next two years. Banks have become more conservative with market volatility and macroeconomic uncertainty, which should generate attractive opportunities for private credit investors to finance or refinance strong companies. Furthermore, the lack of supply and increasing demand for private credit means lenders can usually negotiate stronger protections on deals, increasing Asia credit’s relative value premium.

Liquid Credit: A Large and Expanding Investment Gateway

With dollar and local-currency bonds valued at US$68 trillion, the liquid credit market in Asia Pacific is second in size only to the United States and offers meaningfully higher yields with lower duration than the United States or Europe (Exhibit 3).

EXHIBIT 3: Asia Pacific Liquid Credit Offers Higher Yields and Lower Duration than US

Recently, two crucial recalibrations have also improved diversification in the public credit market. First, the Chinese real estate issuers that once dominated the high yield bond market now play a lesser role. Their bonds made up just 7% of the benchmark index as of 2023 compared to almost 50% in mid-2020. Second, the expansion of the benchmark index in 2023 to include Japan and Australia means China now only represents 25% of the index, compared to 43% previously.

Investment-Grade Bonds: The Potential to Deliver High-Quality Returns that Carry Less Weight

Asia Pacific investment grade bonds can be a good diversifier for a global portfolio given the high-quality (average rating of A-) universe, relatively low exhibited volatility, and the large proportion directly or indirectly linked to sovereign risk.

Compared with the United States on a risk-return basis, Asia Pacific has higher spreads and lower duration across every rating bucket. We believe the sweet spot is in the A to BBB range, where investors can get as much as a 50 basis-point pick-up among high-quality credits. Furthermore, this rating range makes up 75% of the Asia Pacific investment grade universe, so there is room for active management and credit selection to add alpha.

In Summary

Asia Pacific credit markets should offer investors a host of attractive opportunities over the next 10 years, underpinned by positive factors such as robust macro tailwinds, structural reforms, favourable demographics, as well as an expanding middle class. As the region’s businesses seek diversified funding sources to expand, flexible capital providers have a compelling investment sweet spot.