Alternative investment manager Ares SSG is prioritising downside protection before making additions to its portfolio, at a time when global investors’ demand for distressed opportunities in the Asia-Pacific rise to a new level amid the pandemic crisis.
There is “a healthy and strong demand” from investors worldwide to allocate money to emerging markets in Asia, especially to the distressed and special situations space, said Ares SSG’s managing partner and CEO Edwin Wong, during a fireside chat at the Asia PE-VC Summit 2021. “It is clear that the opportunity set is unique in Asia and will not go away anytime soon.”
“The most important thing” amid the global health crisis for Ares SSG – which focuses on credit investment across the Asia Pacific – is downside protection before “adding any more risks to the books,” said Wong. “As a firm, we probably spend 30-40% of our time on risk management versus finding new transactions.”
As of September 2020, the region’s private debt market booked a record $59 billion in assets under management (AUM), marking a growth of 195% in the previous five years. But the Asia-Pacific is still significantly smaller as compared to North America and Europe, which collectively account for 91% of global AUM, shows Preqin data.
Investors are flocking in to build or deepen their credit presence in the region. AustralianSuper, Australia’s largest pension fund with over $225 billion in member assets, announced in July a plan to triple its private credit portfolio to over A$15 billion ($11.1 billion) in the next three years. In June, New York-based Muzinich & Co roped in Singapore bank DBS Group to be an anchor investor in its first Asia Pacific private debt fund, following the fund’s launch roughly one year earlier.
The trend grows bigger with a recent series of fundraising updates, executive hires, and capital commitments involving players from asset managers like Barings, Tanarra Credit Partners, and Fidelity International; to limited partners (LPs) such as South Korea’s Public Officials Benefit Association (POBA), Ontario Teachers’ Pension Plan, and Canadian benefit pension plan OMERS.
Ares SSG, a subsidiary of US-based Ares Management Corporation, is among the latest to raise the stakes in the sector with the final close of its Secured Lending Opportunities Fund III at over $1.6 billion in July. Fund III, which already deployed over a quarter of the committed capital, is twice as big as the $800 million-plus predecessor fund closed in 2017.
As one of Asia’s biggest alternative asset managers, Ares SSG has a team of over 85 professionals across nine local offices, managing approximately $7.5 billion.
While investors are bullish on opportunities in the virus-ridden market, Wong warned that the pandemic also made the restructuring process more difficult. “The storm must clear to some degree, for everyone to agree on a set of projections [around the business to be restructured],” he said.
How much capital have you deployed from your $1.6 billion-plus third secured lending fund? Since you focus on the Asia-Pacific region, which countries have you invested more money in?
For our latest lending fund, we have already deployed a little over a quarter of the committed capital. We’re more active in China and India, while the rest is spread out between SE Asia and Australia.
Which Asian market do you consider to be the biggest right now for special situations and alternative capital players like yourself?
If you look at special situations and distressed investing, India is probably the largest market in terms of absolute size. That has to do with the fact that India is a large economy that has gone through much stress over the past many years, even pre-COVID. The amount of stressed assets in the banking system has been large. And obviously, the COVID has taken the number to a new level. We have seen a lot of activity in India over the last 12-18 months, and we expect it to continue for some time to come.
We have been active in acquiring loans from banks and non-banks in India. We continue to see that as a big opportunity set, as India’s banking system is forecast to have a double-digit NPL ratio and as institutions look to dispose of assets – either because of liquidity or it’s just too much strain for them to hold on to these assets. You need special licences and expertise in how to work them out and then restructure them.
As of today, we have about 19 people, as well as an affiliated servicing company with 40-plus people on the ground in India. They are supported by our team in Hong Kong and Singapore. Our bandwidth for that country is significant. That compares to China, where we have about 20 people on the ground.
I would say that a close second will be China. China is going through an interesting phase. The opportunity has really opened, especially regarding the country’s stressed assets. What’s grabbing the headlines almost every day now is something that we haven’t seen in the past. Companies are being traded as if they’re going to be restructured, meaning that the number of companies that need to be structured is going to be significant. In the past, most companies ended up getting some sort of bailed out, so the event of a default, and ultimately, a restructuring used to be less of a common thing.
In our previous interview in September 2020, you mentioned great potential in the real estate and financial services sectors in India and China. Has your team managed to capture any quality deals in these areas that you could share with us? Has there been any change in these opportunities or any new industries that you’re looking out for?
Those two sectors continue to be where we’re more active in. In the financial sector, especially last year when the COVID hit, banks and non-banks were going through a lot of financial difficulties. The ability to step in and provide capital solutions for them was one of the main themes for us. We have been actively investing across banks and nonbanks, buying good assets, non-performing assets (NPA), and even putting equity into some of these companies. That has done extremely well today.
Real estate is another one that has thrown up a lot of opportunities across the Asia-Pacific region. During the COVID, there have been more distressed real estate assets. In Southeast Asia, for example, residential and hospitality, as well as the real estate sector in general, is rather depressed. India’s real estate sector has been distressed even before the COVID. If anything, the market is actually rebounding or getting a bit of life now given some of the policy initiatives, so we’re seeing some healthy recovery in parts of India. China represents a huge opportunity looking at the amount of debt that has been raised and the amount of restructuring that is likely to happen that could resize the sector. I think that itself is a huge opportunity for people who understand complicated credits views, the nuances around being onshore and offshore, and so forth.
We’ve been dragged onto the second year of the pandemic. As an investor who has weathered several market downturns since you started the firm in 2009, how do you strike a balance between making new investments versus providing downside protection to portfolios?
The one thing that we prioritise is the risk that we have on the books. Our internal meetings always start with the risks that we have and how we manage them before we talk about the pipeline [of potential new investments]. The most important thing for us is to manage our risks well before we start thinking about adding any more risks to the books. That is the philosophy that we have as a firm. Having been an investor since the Asian financial crisis, we have gone through a number of cycles. We’re sitting here today, feeling pretty good about the opportunity set, because we know how to work out certain assets that are underperforming. That is just part of the experience that you accumulate over the years.
One of our strengths is being very local, operating out of nine different offices. As the COVID hit the Asia-Pacific region, we’re fortunate enough to have people on the ground to help our assets navigate the crisis. Our local team not only originate and execute new transactions but also spend a lot of time managing portfolio companies.
Could you please share your experience on the restructuring side of the business? Any obstacles caused by travel restrictions during the pandemic?
There are two major impacts. Firstly, whether it is restructuring or non-restructuring, the business side of things did get impacted across metrics like top line and EBITA. This situation makes restructuring very hard because you don’t really know what to restructure until you have some stability. The storm must clear to some degree, for everyone to agree on a set of projections. And then, you have issues when courts are closed. It delays the process of restructuring, enforcement, and so forth.
But one thing to highlight in Asia is: Even though we’re not out of the woods yet, I would say, by and large, most economies are working through the COVID now. I think we’ve all found a way to get back to business, even though the COVID is still very much around us.
If we could quantify it, how much proportion of your team’s time and energy currently goes into downside protection? When it comes to downside protection, what value-add do you consider as the most needed by portfolio companies these days?
As a firm, we probably spend 30%-40% of our time on risk management versus finding new transactions. Bear in mind that we’re more credit-oriented. Ideally, when we make a loan, there should not incur a lot of brain-damaging on day one or at all, because that certainly would not be part of the underwriting thesis. For the performing side of our strategy, we talk to portfolio companies on a regular basis but that should be of much lower maintenance. The stressed part of our business is where we spend more time on risk management.
To your second question, first and foremost – especially during the COVID – is making sure that we’re in touch with them. There is a lot of bouncing off ideas. It could be capital-related, or the experience, the upstream and downstream relationships, as well as the touchpoints that we’ve accumulated after years of investing across sectors in many Asia-Pacific countries. We offer advice and help stabilise businesses through means beyond just providing capital. Our team spends a fair amount of time working especially on the restructuring side, providing value-add in rightsizing capital structure, taking out non-core assets, and even helping replace operating management.
Many thought there would be an increased demand for private credit solutions amid the COVID. But data from Preqin shows that private credit in Asia has suffered a virus-induced slowdown, with the aggregate private debt raised in the region being only $2.7 billion as of July. What’s your read of the data?
I would rather not comment on the data, because data in Asia tend to be choppy. Credit, in general, spreads across performing and non-performing. On the performing side, I think the fundraising last year was not as robust as it could have been.
Two things probably affected fundraising. One is that people couldn’t travel. Asia is still a place where people would prefer to meet the managers and the team in person. For smaller managers who are lesser-known, the appetite for big LPs to invest in them without doing site visits is very limited.
Secondly, for the good part of 2020, the pricing in developed markets widened out at the start because of the pandemic. One thing that people love about Asia is the region’s less competition, better pricing, and so forth. But when the pricing in Europe and the US were widening out, people would naturally say: “Well, I’m getting that kind of yield in my backyard, why would I need to go farther out?” That was the case early on in the pandemic. That’s not so much the case anymore, because the yield snapped back to tight levels shortly after that.
As of July, Asia’s amount of private lending has fallen short of Europe’s $37.3 billion and North America’s $49.5 billion, respectively. What do you think are the major impediments holding back a faster growth of the strategy in this part of the world?
I actually think the demand has picked up. We are seeing a healthy and strong demand coming into the region, especially for distressed and special situations. It is clear that the opportunity set is unique in Asia and will not go away anytime soon. Over the last five years or so, we’ve seen more and more big global managers and LPs start shifting money into this strategy in Asia.
In terms of what could make the region even more appealing, I guess it would be the rule of law. This has advanced a lot in the last 20 years, but clearly, there are still inefficiencies in the system. It sometimes takes a bit of education for investors without the background in Asia to get up to speed as to how you underwrite credit and enforce it, or restructure an asset.
Are there more fund managers in Asia looking to tap this segment, as supposedly, demand should have been growing amid credit tightening by traditional banks?
Many famed global managers are already putting together a team or setting up an office in Asia. That trend probably started three or four years ago. Almost all big-name brands are building up a credit presence in the Asian region. While many of them focus on private equity, they do have debt, but more so in Europe and the US. Every one of them is seeing a big opportunity right in front of us.
One of the challenges of building a credit presence in Asia is its high entry barrier. Asia is a market of many different countries, so you need to have local people, offices, licenses, and experience. Unless you are committed and prepared to be here for many years, it is hard to build scale.
How do you navigate markets like China and India where regulations around special situations are still evolving, despite their generally benign attitude towards further opening up to foreign investors?
I think both countries want to attract foreign capital. They recognise that there is a need for alternative capital. I think one thing is clear: There is only so much that banks can do and they’re rather rigid in terms of what they do and don’t do, so alternative credit managers like ourselves have a lot of room to navigate. It is an open playing field for people who are experienced and knowledgeable in making investments in those markets.
What about SE Asian opportunities in general, as compared to other markets in Asia?
The SE Asian market is smaller [than China and India], but its wealth is more concentrated on a list of families. That makes the market easier to cover. Having been investing in SE Asia for almost 25 years with a focus on distressed opportunities, we leverage our local connections to engage in direct conversations with banks and other institutions to provide NPL solutions.
We’re more active in countries like Thailand, Indonesia, and Vietnam. That’s not to say that we don’t look at other jurisdictions. We’re looking at opportunities in Malaysia and the Philippines, for example. But those markets are a bit smaller, so we are probably not as active in those countries as we are in countries where we have people on the ground.
Besides India, China, and SE Asia, we also invest in the relatively untapped unitranche market in Australia.