APAC developed: a compelling growth story

Why developed APAC?

There is much to be said for a focus on the developed regions within APAC, such as Australia, New Zealand, Singapore and Hong Kong.

These economies exhibit similar risk and return profiles to those typical of the major direct lending strategies in the US and Europe, with the added benefit of diversification and access to attractive global growth opportunities. Importantly, the regulations and bankruptcy laws in these countries are similar to those in other developed markets, meaning enforcement procedures are reliable and transparent. Furthermore, sovereign credit ratings in these regions are comparable to, and in some cases better than, those in the US and Europe.

Through direct investment in developed APAC it is also possible to gain indirect exposure to the growth potential of emerging economies such as China, India and Indonesia – but with less idiosyncratic jurisdictional risk. In our view, these are currently less attractive regions from a senior secured direct lending perspective, given the specific risks around legal structures and security enforcement.

An attractive risk-return profile

The developed direct lending market in the APAC region is still relatively infancy compared to the US and Europe, but offers similar risk and return characteristics. Because these regions are smaller in size and less developed from a capital markets perspective, while the mid-market companies have similar EBITDA profiles ($15 to $100-plus million), they tend to rank first or second in their field and have a dominant market share. . Leverage levels are generally consistent with trades on the US and European markets, but in some cases are even slightly lower. Prices also tend to be less volatile and documentation is relatively conservative.

While mid-cap companies in developed APAC have largely remained healthy, investors should also pay attention to sector selection. Companies in more defensive sectors, such as education and healthcare, tend to have more consistent operating profits, higher cash flows and strong interest coverage. Demand tends to be less discretionary or price sensitive and therefore companies in these sectors tend to be less affected by changing economic conditions.

Why now?

Today’s direct lending opportunities in APAC are rooted in the region’s growth story. In addition to historically benefiting from strong economic growth, demand for non-bank financing is strong – especially in Australia and New Zealand – thanks to increased private equity activity from international and local PE sponsors.

The increase in the number of non-bank lenders has also helped expand the breadth and depth of the direct lending market. Before the growth of the market, both in size and number of deals, it was arguably not deep enough to build standalone, diversified portfolios.

But the landscape has evolved, and managers are also better positioned to offer more viable solutions to private equity sponsors, and to more meaningfully fill the void left by the banks. Investor interest in direct loans has also increased. As the story and understanding around these markets continues to grow, especially among foreign sponsors and investors, we believe the opportunities will continue.

Shane Forster and Justin Hooley are portfolio managers for Barings’ Asia Pacific Private Finance Group.