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Allianz is exposed to nearly all strategies it offers externally, to a greater or lesser extent. Internal and external clients naturally need to be treated fairly. Larger or earlier investors may get better terms on fees, whether they are Allianz or third parties. Investment vehicles can be comingled and pooled, or could be dedicated to single investors for larger allocations. The client base is institutional, and includes substantial allocations from insurance companies and pension funds, where credit ratings and transparency can be important under Solvency II.

Private credit spans a wide spectrum of risk and reward, with return targets ranging from about 1% to 15%, and credit ratings including investment grade, non-investment grade and some non-rated exposures. It includes strategies where few if any borrowers have credit ratings, though equivalent ratings can be mapped, based on metrics such as leverage multiples. Portfolio transparency also aims to offer look-through reporting, which can be useful for obtaining lower Solvency II capital charges. Whether investors could use the portfolio reporting and mapped credit ratings for Solvency II purposes would depend on their internal models.

Allianz has exposure to developed markets mainly in the US and Europe, and also emerging markets including infrastructure debt in Latin America, and blended finance deals in Africa in conjunction with development finance institutions. Currently, Asian private credit, which combines some developed markets such as Australia, and some emerging markets such as India, may offer the most compelling value in either developed or emerging markets – in absolute and relative terms.

This is in USD after some deals in Australian Dollar, New Zealand Dollar or Indian Rupee have been hedged back. In relative terms, this represents a yield pickup of between 250 and 450 basis points over broadly comparable risks in the US and Europe. (The mapped credit ratings are ‘BB’ equivalent for the senior secured strategy, and ‘B’ equivalent for direct lending). The legal risk framework is similar. Private credit covenants are generally stronger than in public markets, including in Asia. Legal documentation is predominantly in English law, and other legal systems, such as Singapore, Hong Kong, Australia and India, which are based on English law. Finance security can use local law, and Allianz has a strong influence on terms and packages.

Clean EBITDA Growth and Strong Governance

On a risk-adjusted basis, the yield pickup might even be more attractive, because the metrics used to calculate leverage multiples can be much cleaner. EBITDA adjustments, which can mean true leverage is much higher than the headline figures, are widespread in the US and Europe, but are much rarer in Asia, where definitions are much tighter. Therefore, typical multiples of 3.5 times EBITDA for senior secured lending, and 4.5 times EBITDA for direct lending, are meaningful.

And if the starting point for leverage may be lower, it gets better over time. Asia’s stronger economic growth allows the strategy to deleverage, and also makes credit attractive to entrepreneurs who want to avoid the dilution that could be entailed in public or private equity. They would rather not prematurely give up equity when they could make a much more lucrative exit in a few years’ time. (Allianz does occasionally take equity kickers such as warrants on the direct lending side, when equity value could be disproportionate relative to its capital).

Though these individuals are independent-minded, they will also consent to reasonably intrusive governance rights, such as board observer rights, board seats and cash monitoring on the direct lending side.

Relationships, Origination, Defaults and Workouts

This is a relationship-based business where Allianz’s team have originated 75% of their own dealflow, mainly from founders, though there can be some financial sponsors. Most deals are bilateral, though the largest ones are sometimes syndicated with other institutions or banks. The uses of finance include growth, acquisition and refinancing, with an approximately even split amongst the three: for senior secured and direct lending the splits are 41/32/27 and 34/37/29 respectively. The senior secured lending strategy would not lend to the same borrowers as the direct lending strategy, as that could create a potential conflict.

Whereas some Allianz strategies, such as senior investment grade debt, have a zero loss underwriting philosophy, and have had no defaults for over a decade, Asian private credit has historically seen some occasional defaults and small losses. Of 88 deals that the team invested in since 2010, five had restructuring issues, with the worst return being an IRR of minus 5%. The reasons for losses have tended to be negative sector dynamics such as a new competitor driving down margins. There has not been any fraud.

Growth Sectors and ESG

The sector focus on software, data centres, healthcare, education, packaging, pharmaceuticals, real estate, food/food retail, telecom and waste management is essentially investing in secular growth and defensive sectors, which are often assetheavy and have strong cashflows. The strategy avoids cyclical sectors such as apparel, auto OEMs and suppliers, consumer durables, travel and leisure, retail and shipping.

ESG is also influencing sector choices, as some deals are driven by energy transition and renewables. For instance, most new generation in India comes from renewables, which also requires reinforcement of networks to handle intermittency.

European investors have growing ESG reporting needs, such as carbon footprints and SFDR (Sustainable Finance Disclosure Requirement), which is being phased in between now and 2023, and their borrowers will provide enough transparency; medium-sized companies in Asia should increasingly be willing to disclose enough data, because they need to do this to access finance.

Yield Compression?

The Covid crisis initially increased yields, between March and October 2020. Yields have now reverted to pre-Covid levels, especially in more mature markets such as Australia and New Zealand, but we do not see signs of further yield compression. There are structural reasons for yields in the Asia Pacific region remaining higher, at least outside China, where Allianz do not see the same supply/demand imbalances.

On the demand side, high growth generates a strong demand for credit. On the supply side, Asian public markets cater mainly for larger borrowers; Asia is under-banked, and does not have the structured credit collateralised loan obligations (CLOs) or Business Development Companies (BDCs) and various other vehicles that provide credit for smaller companies in the US and parts of Europe. There may also be a complexity premium.

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