NEPC plants flag in Asia with direct lending fund

Clients of NEPC LLC are putting more than $125 million to work in an Asia-focused direct lending fund, following two years of research on the opportunity by the Boston-based investment consultant.

NEPC officials declined to identify the money manager they selected to partner with, but at least one NEPC client confirmed that OCP Asia, a manager of hedge funds and alternatives strategies with offices in Hong Kong and Singapore, is running the fund. Teall Edds, a partner with OCP Asia, couldn't be reached for comment.

Endowments and foundations are well represented in that first group of more than 10 NEPC clients, which accounted for roughly half of the fund's initial close of $250 million, said Scott Perry, an NEPC partner, in a telephone interview. A number of other NEPC clients are currently doing due diligence, he said.

The capacity of the fund — which NEPC has no direct financial interest in — is roughly $1 billion. “There's no benefit for NEPC, other than clients achieving strong returns,” said Mr. Perry.

The history of investment funds extending credit to small- and medium-sized companies in the U.S. and Europe is longer and deeper, but the opportunity in Asia could prove more persistent and rewarding for clients, Mr. Perry said.

While opportunities in the U.S. and Europe have a cyclical element, enhanced in recent years by regulatory moves to tighten bank capital requirements, from the Dodd-Frank Act in the U.S. to the Basel III global standards, Asia's less efficient capital markets make the opportunity in that region a secular one, Mr. Perry said.

Investment consultants in the region say a handful of money managers in Asia are pursuing direct lending strategies - including PAG (formerly Pacific Alliance Group) and ADM Capital, both of Hong Kong - but interest in that market segment remains nascent.

Even so, there have been signs of growing interest from some of Asia's big institutional investors. In May, for example, Korea Post's insurance division issued an RFP for as many as two money managers to run a combined $100 million in Asia-focused direct lending strategies.

In a telephone interview, Uk Kyung Park, the head of private equity and M&A investment with the Korea Post Insurance Bureau, confirmed the selection of PAG and ADM Capital to manage that mandate.

The direct lending theme is one NEPC is pursuing globally this year, with the firm's predominantly U.S. institutional client base committing $625 million to funds extending credit to small- and midsized U.S. companies and $275 million to funds lending to European companies, Mr. Perry said.

While the Asian strategy shares attractions with its U.S. and European counterparts, such as the investments' floating rate nature — at a time when potential losses on bond holdings from an eventual rebound in interest rates is weighing on asset allocators — the potential returns in the high-growth region could prove particularly attractive, he explained.

A direct lending fund focused on Asia should be able to target returns in the mid-teens, higher than a dedicated European strategy's 10% to 12% or a U.S. strategy's 7% to 10% returns, he added.

And if that leaves the strategy playing more of a private equity role in portfolios, it will offer relatively favorable liquidity terms, said Mr. Perry. The Asia-focused direct lending fund has a lockup of 18 months to three years, less onerous than the five- to seven-year lockups typically required for U.S. and European-focused strategies, he noted.

In that context, the opportunity to exploit a pronounced market inefficiency in Asia with a money manager that's completed more than 160 deals over the past decade and delivered consistently strong returns was an option that the board of the $31.7 million Statler Foundation, an NEPC client, decided to take.

Arthur F. DeCouet Musarra, a Statler trustee and chair of the foundation's finance committee, said in an e-mail that the Asia direct lending opportunity came onto his radar screen as he was grappling with the realization that the top-quartile annualized returns of 5.9% the foundation garnered for the five years through June 30 still weren't sufficient to cover legally mandated spending of 5% of the foundation's principal a year plus inflation.

With 4.9% of the foundation's portfolio in domestic equities, 77.7% in global tactical asset allocation strategies, 7.8% in hedge funds, 9.3% in private equity and opportunistic strategies and a residual 0.3% in cash, Mr. Musarra said an asset allocation study earlier this year resulted in a decision to sell the domestic equity position — after a strong run since 2012 that lowered the prospects for future returns — in lieu of more opportunistic allocations.

As an added incentive, NEPC has managed to lower fees for the fund's limited partners to a management fee of 1.25% and a carry of 10%, well below the 2-and-20 standard, said Mr. Musarra.

Asked if the strategy will be a means for NEPC to pursue institutional clients in Asia, Mr. Perry said it would be more accurate to see this as NEPC's research effort planting its flag in Asia.