Asian institutional investors who are plagued by expensive hedging costs on the US dollar as well as low interest rates are finding European investments more attractive, particularly private debt or direct lending.
“In Japan and Korea, the investors we speak to are insurance companies, pension schemes. In Hong Kong and Singapore, you still get that profile, but on top of that I would add private banks, family offices, sovereigns and the like. Asian investors are very sophisticated in their questions, in their knowledge, and as a portfolio manager explaining the product there is an understanding and a real conversation,” says Patrick Marshall, London-based head of private debt & CLOs at Hermes Investment Management.
Private debt provides institutional investors with a way to increase investment yield in a persistent low-interest rate environment. It also provides investment opportunities for non-bank private direct lenders since European banks are under pressure to restrict their lending to corporates because of Basel III.
Also, private debt in the form of senior secured loans by mid-size corporates from Northern Europe, particularly, Scandinavia, Germany, and Benelux countries offer an additional 50bps in yield when compared to their counterparts in Southern Europe.
In addition, the default environment in Northern Europe is more favourable to private debt direct lenders, providing up to 80% recovery in case of default. Default recovery in the US is slightly lower at 75%, while, default recovery in Southern Europe is significantly lower at 50-60% recovery. Northern Europe also has a positive legal framework and unlike the US market is not as exposed to cyclical industries.
“We believe Northern Europe provides the strongest risk-reward parameters for private debt. This is probably the best region in the world in terms of lender protection,” says Marshall.
In Asia, direct lenders tend to lend to private debt transactions that banks won’t lend to. This private debt model is slightly different from the European model where the direct lenders can compete with the banks for transactions.
“I’m fully aware that we’re seeing a growing number of direct lenders operating in the Asian market but I would argue that Europe is a new frontier for private debt lending. Asia is still in the exploratory phase and there are significant legal risks in certain countries to lend to,” Marshall says.
For its private debt business, Marshall says Hermes has legal agreements with four of the biggest banks in Europe that make these banks legally obliged to share every loan opportunity that they see in their respective regions with his firm. These banks are Royal Bank of Scotland of UK, Danske Bank of Denmark, KBC Group NV of Belgium, and DZ Bank AG of Germany.
“This is a clear differentiator that has enabled us to be involved in loans from the beginning. These aren’t syndications. We structure the loans and we co-lend alongside the banks on the same economic terms. What it means is that unlike any other European direct lenders we’ve been able to access the Scandinavian market which is a very closed market for direct lenders. And right now, I would argue that Scandinavia is where the value is in Europe,” Marshall says.
Hermes currently has two private debt strategies, one focused on the UK market and the other focused on the Northern European market. Both strategies invest in secured senior debt securities of top-rated companies without using leverage.
“All of our loans are floating rate senior secured loans meaning our investors benefit from upside in a rising rate environment and at the same time, all of our loans have Libor or Euribor floors. This means if interest rates are cut, our investors are protected on the downside,” Marshall says.
Marshall declined to provide details of assets under management (AUM) for both strategies and Hermes' private debt business. But published reports indicate that Hermes Investment Management has 36 billion pounds (US$45.8 billion) in AUM as of January 2019. The UK-focused Hermes Direct Lending Fund, launched in August 2018, has a target size of 750 million pounds, according to Prequin.