Asia private credit: Unlocking the complexity premium

February 13, 2025

If you have any feedback on this article or are interested in subscribing to our content, please contact us at opinions@muzinich.com or fill out the form on the right hand side of this page.

--------

With ever-tighter spreads in some parts of the Asian private debt market, the ability to navigate more complex situations could become increasingly important in unlocking returns, argue Andrew Tan and Jieying Huang.

At the start of 2024, there were high hopes for the Asia private credit market, driven by expectations of a pick-up in M&A-related debt financings. Yet it took until the final quarter for activity to recover after political uncertainty in countries such as India and Indonesia receded. 

But while the prospect of a pickup in deal volumes may be increasing, spreads in some countries have tightened considerably. Consequently, we believe the ability to identify and manage more complex situations will become increasingly important in sourcing compelling opportunities for investors.

A barbell approach

Growing competition has resulted in spread compression in parts of Asia, making origination more challenging - especially in the upper-middle market. Deal structures are becoming looser and covenants weaker.¹ Where spreads are concerned, larger deals are starting to see spread compression to varying degrees. In India and Australia, for example, spreads on senior-secured direct lending transactions have compressed around 150-200 basis points over the past 2 years.

Our focus on lending to lower and core middle market companies in the Asia Pacific region has provided some protection against these headwinds. Less competition in this segment combined with an ability to negotiate bespoke structural protections and covenants allows us to source opportunities that can still deliver attractive returns.

Given the current market backdrop, to enhance returns and diversification at a portfolio level, we adopt a barbell approach. Segments and markets with tighter spreads remain relevant given the relatively straightforward nature of the deals and need for ongoing financing. These transactions can therefore form the lower-risk backbone of a portfolio.

Beyond such loans, we see opportunities to extract additional alpha – a ‘complexity’ premium - from more structured transactions, including those with equity linked or upside-sharing features. These can be found in markets such as Singapore, Hong Kong, Indonesia and, opportunistically, in Southeast Asia. While deals may take longer to come to fruition and are more complex to structure, they can complement the less complex “backbone” to help us construct well-balanced portfolios. 

Greater complexity does not necessarily mean a disproportionately higher level of risk. While lower-middle market borrowers tend to be less levered than their larger counterparts, risk management and underwriting discipline remain critical. From a structural perspective, a strong risk focus is essential in the event of a default; lenders should ensure they are able to efficiently enforce their security over assets whose value outweighs the debt.

Opportunities in real assets

The global energy transition and shift in manufacturing supply chains to reduce dependency on China² could have a significant influence on the Asia private credit market. In particular, we see opportunities in real assets and infrastructure, including in areas such as utilities, telecoms, underground fibre optic cables and renewable energy, all of which require significant capital on top of public funding, which tends to be focused on larger projects.³ 

With smaller/privately held companies struggling to secure financing, there is an opportunity for private lenders to provide bridge financing during the last mile for projects as they move towards their intended operating capacity, especially given the dilutive effect of additional equity at this late stage.

We see companies approaching lenders for loans of US$25-100 million to provide support until full operational capacity is reached and they qualify for bank financing. In our view, such deals can offer particularly attractive risk-adjusted returns in the current environment.

A differentiated approach

The US and European private credit markets are sizeable and established among global investors. Yet the amount of capital chasing opportunities is compressing spreads,⁴ while there is considerable overlap in terms of holdings between strategies at the upper end of the market.⁵   

In comparison, the private credit market in Asia is still emerging, with significant room to grow given the number of countries in which transactions can be originated and need for finance in more idiosyncratic and situational settings. For international investors who have to date largely ignored the region, we believe Asian private credit could offer a different and attractive option to complement their allocations to US and Europe-focused strategies.

With private equity sponsors well served by banks,⁶ Asia Pacific private credit typically sees a far greater proportion of opportunities in non-sponsor transactions,⁷ particularly those involving lower middle market companies. We see a prime opportunity for private lenders to step in and provide much-needed financing in return for an attractive risk premium.

However, access to a steady flow of suitable transactions is dependent on the strength of manager relationships with corporates. Many are family-owned and not covered by large investment banks but by independent boutique corporate finance advisors. Strong connectivity and relationships with these networks of advisors is key and takes many years to build in the different markets in Asia Pacific.

Demand likely to remain elevated

Looking ahead, we believe Asian private credit could be poised for significant expansion, with estimates of 8% annualised growth over the next 5 years,⁸ which would result in a c. US$160 billion market by the end of the decade.

There are several long-term structural factors to support this. First, given the strong economic growth outlook for the region, there will be ongoing and increasing demand for capital from banks and private lenders. Second, the contraction of the Asian high-yield bond market,⁹ driven in part by problems in the China real estate sector, has already led to companies seeking financing from elsewhere. This is where alternative lenders have come into play and will likely continue to take market share, especially with what would have been first-time issuers in the high-yield bond market.

It is our view, the asset class may grow even quicker than projected, although it depends on risk appetite and whether banks move towards the ‘originate-to-distribute’ or ‘originate-and-share’ operating model adopted by their European and North American peers. The more prominent this shift becomes, the quicker the growth.

However, given private credit’s track record of providing potentially attractive income with reduced volatility, we believe investor demand will continue to grow. Managers that can navigate more idiosyncratic situations and access the ‘complexity premium’ for their clients could find themselves at the forefront of the market’s next phase.

References

1. Pitchbook, ‘Private credit recoveries in focus,’ November 13, 2024
2. McKinsey, ‘Diversifying global supply chains: Opportunities in Southeast Asia,’ September 5, 2024
3. McKinsey & Company, Diversifying global supply chains: Opportunities in Southeast Asia, as of 5th September 2024.
4. Bloomberg, ‘Private Credit Is Eyeing Bigger Margins on Loans,’ August 10, 2024
5. IMF, ‘Global Financial Stability Report,’ April 16, 2024
6. Dechert ‘Global Private Equity Outlook 2025,’ November 12, 2024.
7. Hong Kong Monetary Authority, ‘The financial stability implications of the private credit sector in Asia-Pacific,’ April 29, 2024
8. Preqin, ‘The Future of Alternatives 2029, data pack October 2024. Annualised growth estimate from 2023-2029 include direct lending (9.7%) distressed debt (7.1%) and Other (7.7%) totalling 8.1%
9. JP Morgan, ‘EM Corporate Outlook & Strategy 2025,’ November 26, 2024.

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of February 2025 and may change without notice.

--------

Important information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of future activities and future performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2025-02-04-15385