Although private debt has grown in profile as an investment option, South Korean investors are reluctant to adopt strategies that capitalize on debt mispricing, saying they prefer a conservative portfolio that protects investors against losses.

Instead, they are looking to increase safety of investment with a focus on diversification and recession-proof sectors.

“We will continue to invest in defensive sectors and construct a well-diversified portfolio, as we prefer an all-weather strategy in the market with high uncertainties,” Park Wan-sun, head of the overseas alternative investment team at Fubon Hyundai Life Insurance, said at the PDI Japan Korea Week 2021 Virtual Experience, an investor forum on Nov. 10 by London-based market intelligence firm PEI.

Private debt is now gaining attention as a fast-emerging alternative investment, based on forecasts that demand for nonbank borrowing will increase among companies or projects involving real assets. According to PEI, private debt fundraising in the first three quarters of 2021 surged 18.2 percent to $139.5 billion across the world.

Private debt ranges in risk level, from relatively safe senior debt to direct lending, mezzanine, special situations and the riskiest, distressed debt.

In the latter two, the strategies are largely designed to take advantage of what investors believe is price displacement -- in other words, they think some debt assets are priced incorrectly.

Special situations investing targets borrowers that have sound fundamentals but are affected by external uncertainties, while distressed debt investing focuses on debts issued or borrowed by entities in financial trouble.

Fubon Hyundai Life Insurance, the Korean insurance arm of Taipei-based Fubon Group, has committed $400 million capital to blind pool funds dedicated to private debt this year, with 70 percent of them targeting direct lending and other nonbank loans. According to Park, its commitment to private debt will amount to $500 million next year.

Meanwhile, Hyundai Marine & Fire Insurance, which has allocated $880 million in private debts, are now sourcing new deals for nonbank direct lending and mezzanine investing through fund managers. Moreover, the institutional investor has started to directly invest in acquisition financing.

According to its representative, these private debt strategies are aimed at securing a protection, as the risky bets are considered premature to Korean allocators at the nascent stage of private debt investing.

“We have strategically focused on direct lending and mezzanine debts, and we may also consider investing in credits in special situations and distressed debts in the future,” said Oh Inn-chul, senior manager at Hyundai Marine & Fire Insurance.

“But we will take a wait-and-see approach. And that’s where the challenges would come from.”

According to Oh, some private debt fund managers with risk appetite tout their performance as resilient and consistent, but there are often questions as to whether their performance is driven by the fund managers’ actions or by the current high levels of market liquidity.

“That’s why we are taking a closer look at how our existing external managers are responding to the changes (in the post-COVID era),” Oh said.

Korean fund houses echoed Korean allocators’ point of view in terms of their pursuit of safety.

One of them, VI Asset Management, saw nonbank direct lending as its core private debt strategy, deploying over half of capital out of its total private debt investment.

“We capitalize on direct lending strategies because these are targeting secured senior loans with collateral. It offers a downside protection with a loan covenant, so that institutional investors are able to seek protection and deliver decent return on investment,” said Lee Ha-kyoung, chief investment officer of VI Asset Management.

Meanwhile, distressed debt investing is fading in Korea.

“Distressed debts have been in the spotlight immediately after the COVID-19 pandemic outbreak. But the market addressed this issue quickly and normalized, balancing out the bond price misplacement. Since then, distressed investing in private debt has not been common,” said Eugene So, head of global alternative investments team at IBK Securities.

Both insurers in Korea have been reluctant to enter newly emerging private debt markets.

Geographically, North America and Europe are major regions for private debt investing. The regions’ focus of capital targeted by funds, excluding multiregional funds, were estimated to reach a combined $239.7 billion as of September, taking up 73 percent of the total capital, according to PEI’s estimate.

The Asia-Pacific region is a fast growing market, but capital targeting the region is still just $16.4 billion.

While Park of Fubon Hyundai expressed an intention to expand to the North American market from its focus on European market, he said it was premature to have exposure to private debt deals in Asia, where the concept of private debt investing is relatively new and commercial lenders dominate the lending market.

“We don’t have a plan to invest in Asia-focused private debt funds yet,” Park said.

Korean institutional investors’ conservative-leaning risk management and review process often leaves them with few chances to blaze a trail.

And even asset-based lending can be difficult to assess because the scope of what can be used as collateral is very wide.

“There are myriad underlying asset classes for asset-based lending strategies, and the way the investment is structured. So it’s not easy to deliver all of the different strategies to assess risks,” Oh of Hyundai Marine & Fire said.

As to what matters in choosing managers to handle private debt exposure, they brought up a private debt fund manager’s capability to use up their dry powder as quickly as possible.

“We highly value external partners that are capable of depleting uncalled capital commitments quickly and constantly continuing to invest,” Oh said. “We monitor fund managers’ investment activities by looking at their funds’ cash flows.”

This indicates how long the fund manager takes to use the free capital. Unused capital commitments translate into higher costs for Korean insurance companies, which are subject to toughening capital adequacy regulations.

“Korean insurance firms impose capital charges not only on drawn amounts but also unfunded capital commitments. So it is more desirable for Korean insurers’ capital commitment to be deployed by fund managers to generate profit,” Park of Fubon Hyundai said.

PEI is a media partner of The Korea Herald.