Despite the pandemic increasing the risk of doing so, institutional investors in South Korea said they would venture into unfamiliar nonbank financing bets, such as private debt funds.

Representatives of Korean investors said last week at PDI Seoul Forum Virtual Experience 2020 that they are developing an eye for suitable external partners dedicated to private debt fund management, as this particular asset class has become a more reliable source of income than traditional assets like stocks, which are more volatile because of their higher liquidity.

Private debt involves financing via nontradable loans to unlisted corporations, real estate or infrastructure assets. 

In the wake of the 2008 global financial crisis, capital across the world has flocked to private debt in the United States and Europe, which is rapidly taking the place of banks. 

Most notably, the Public Officials Benefit Association has allocated nearly 60 percent of the 15.6 trillion won ($14 billion) worth of assets that it manages to alternative investments -- a category that includes private debt investing.

Though it maintained a somewhat conservative approach in the pre-COVID-19 era, POBA has recently turned to distressed debts while balancing that against more investment in secured senior debts in what is known as a “barbell strategy” -- investing in a mix of risky and safe assets.

“In a way, you can say that COVID-19 has ironically provided us with a rare chance to invest in distressed assets,” POBA Chief Investment Officer Jang Dong-hun said. 

“Just because this COVID situation created quite an attractive opportunity to be more opportunistic in the distressed debt areas, we are preparing to select those distressed debt areas next year.”

The remark comes as investors in private debt are largely plagued by COVID-19 uncertainties as the pandemic has reduced the ability of companies and property owners to keep up with payments. 

In addition, private debt investors in Korea found it difficult to carry out on-site due diligence on assets primarily in Europe and the US due to travel restrictions. Turning their attention to Korea is unlikely, as it largely regards direct lending as the exclusive domain of commercial banks.

This situation is encouraging Korean institutional investors to look for risk-savvy fund management partners.

“We learned how important it is for a local partner to have experience in distressed debt investment and to be equipped with the capability to manage risks,” Jang said.

He added that POBA’s existing partners have been reliable in that they have been willing to share the fresh investment opportunities that COVID-19 has offered and have a deeper mutual understanding with the institutional investor.

Sorting wheat from chaff

Good external partners, from Korean institutional investors’ perspective, are not only experienced but also trustworthy and consistent.

The COVID-19 turmoil dispelled some illusions about private debt pricing, confronting fund managers with what is apparently the toughest test since 2008. The way the fund managers dealt with the challenges made all the difference, DGB Life Insurance Chief Investment Officer Cheon Byung-kyu said.

“Given that private debt is an asset class that rose to popularity in recent years, we rarely had chances to observe how private debt funds would react to each phase of the economic cycle,” Cheon said.

He added that COVID-19 offered DGB Life Insurance, which oversees 6.5 trillion won in assets, a chance to tell which partner was true to its underlying philosophy or initial investment plans, allowing them to rate external blind pool fund partners accordingly.

“There were discrepancies among our partners as to how consistent they have been when acting under their investment philosophy and how well they communicated with (end-investors) under an extraordinary economic situation.”

Park Wan-sun, deputy general manager of Fubon Hyundai Life Insurance, said the COVID-19 crisis is testing whether measures that were touted as being good for downside protection really worked in the comparatively new and immature market.

“Now that the benign market gives way to turbulence, we are able to sort the wheat from the chaff,” he said.

Korean asset management companies and brokerages stressed the need to take preemptive actions and to gauge risk-return profiles with accuracy in volatile times, as there is room for them to assist Korean institutional investors and foreign private debt fund managers by serving as intermediaries.

“We asked our debt fund partners to manage risk exposure preemptively, based on our experience when dealing with major macroeconomic events such as Brexit,” said Yeon Kyu-huhn, head of global alternative investments at Shinhan BNP Paribas Asset Management.

Kiwoom Securities’ Sim Kwang-jin, head of the multifinancial products team, said Korean investors are increasingly open to new techniques to measure the capabilities of potential partners to control risks, having witnessed a series of private fund fiascos here centering on hedge funds such as Lime and Optimus.

“We have begun to take into account our partners’ internal control and apply operational due diligence techniques for risk management,” Sim said. 

Bet on Asian debts unlikely

Representatives of Korean institutional investors also said they were unlikely to bet on Asian private debts in the near future, despite the region’s moderate success in virus containment compared with Europe and the US.

The lack of sophistication in the legal framework and a sense of alienation toward the market have so far left Korean investors less convinced.

“People say opportunities abound in the Asian private debt market, but regardless of how well they coped with the coronavirus, we will continue to focus on the conventional market with a proven track record,” said Ahn Kwang-min, head of private equity at the Government Employees Pension Service.

Cheon of DGB Life Insurance cited the lack of common standards in pricing private debts in Asia, as well as the commercial banks’ dominance as primary lenders in the lending market.

“We find the Asian private debt market attractive and it will grow larger. ... But there is still a lack of uniformity in terms of pricing and determining risk-return profiles,” Cheon said.

“What fueled private debt market growth in the United States was banks’ retreat from the lending market in the US. That’s not the case in Asia because many banks are strongly supported by the government and remain dominant in the credit market.”

By Son Ji-hyoung (consnow@heraldcorp.com)