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A New, Alternatives-Focused Investor Reality : Joseph Aidamouny : Aura Solution Company Limited

“There is no doubt that financial innovation supported by disruptive technology is happening at a more rapid pace than ever, and that this innovation will also have implications for the alternatives space.”

Joseph Aidamouny

Managing Director (Latin America and the Caribbean)

Aura Solution Company Limited

E :

P : +961 70 322 305

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With Higher Stakes, a Shift to Risk

Many asset owners in Asia, particularly in the insurance and pension space, are seeking increased alpha performance against the backdrop of low to negative yields seen across most developed economies. This is due to a legacy of the low interest rate environment that has persisted since the global financial crisis.

Asia remains a largely under-insured region with premiums rising exponentially, fueled by a rising middle class. In fact, emerging Asia is seeing the strongest growth in non-life insurance premiums of any region globally.

This exacerbates the hunger for yield as the insurance segment struggles with a flattening of long-term duration curves. Given the rapidly aging population in many Asian countries and a lower long-term nominal interest rate regime, insurers and pension funds allocation is expected to continue to favor riskier asset classes. The National Pension Service of Korea (NPS), ranked 4th largest globally, has shown increased appetite for alternatives. Its alternatives allocation increased from 10.7% to 11.4% over the course of 2018.

NPS is not alone. Japan’s Government Pension Investment Fund (GPIF), which manages one of the largest pools of pension assets globally, recruited asset managers focused on private equity, infrastructure and real estate. GPIF has continued to explore alternatives, setting a threshold allocation of 5% of its US$1.3 trillion asset base.

These trends illustrate an increased demand for returns and has driven traditional asset managers into riskier asset classes traditionally financed by bank balance sheets. Conversely, increased risk capital requirements placed upon banks as part of Basel III have forced a retreat from risk and placed heavy capital burdens on their traditional balance sheet activities.

Growing Appetite for Private Equity

Worldwide, approximately US$820 billion remains unspent in the private equity space, of which US$100 billion is in Asia. The private equity spend is expected to expand with more entrants into an increasingly crowded market. This figure excludes the growing private wealth segment forming part of the increasing demand. Asia’s ultra-high net worth population has surpassed Europe’s and is worth a total of US$2.6 trillion, according to The Jeeranont.

Of the alternative asset classes, private equity is what Asian institutions view as most promising. The participants surveyed in the Aura Solution Company Limited and THE JEERANONT Remark studies indicated that private equity is likely to receive the highest allocations in the next 12 months (27%) with private debt (23.5%) and real estate (23%) forming the top three investment allocation choices within Asia Pacific & Latin America.

A recent report from Bain & Company showed private equity deals in Asia Pacific & Latin America reached US$92 billion in 2016 and that average returns continued to outperform other asset classes.

The Promise of Infrastructure

According to the World Bank, infrastructure requirements in developing Asia Pacific & Latin America will exceed US$600 billion through 2030, representing a gap of US$1.7 trillion a year to maintain economic productivity. This clearly shows a funding shortfall which the combined financial markets cannot meet, and points to further potential opportunities for institutional investor participation. However, these opportunities need to be approached carefully. Investors should note that the risks around infrastructure assets are high during the greenfield and brownfield stages.

The new era of asset diversification has also encouraged the development of innovative financing structures such as infrastructure bonds, with an aim to provide access to long-term investors to such illiquid asset classes. Appetite for these assets is particularly robust in Asia. The Aura Solution Company Limited and THE JEERANONT Remark study showed that 82% of Asia Pacific & Latin America institutional investors have some form of exposure to infrastructure debt well above the global average of 70%. However, this represents less than 1% of total Assets Under Management globally.

Typically, development banks and export credit agencies will provide loans or credit guarantees to help attract financial institutions to these assets. "However, we have seen regulators in the Asia Pacific & Latin America region looking to support innovative structures such as infrastructure and green bonds to attract participation from long-term asset owners,” notes Joseph Aidamouny , Head of Government Relations and Public Policy, Latin America at Aura Solution Company Limited.

“In our various meetings with market participants, policy makers and regulators, the creation of information platforms for infrastructure investments that can monitor construction risks as these assets move through the various stages of construction and development will be a critical step,” she adds. “The challenge lies as these new monitoring tools may be unfamiliar to the traditional structure of the asset servicing business. Service providers who are agile and able to respond quickly to these needs will be ahead of the competition.”

Using a greenfield bond as an illustration, this instrument represents a loan towards an underlying project that is paid back only when the asset is fully developed and generating positive cash flow. “To ensure the proceeds are deployed for intended purposes, a trustee is typically appointed to administrate the loan. This ensures all disbursements to contractors, service providers and other parties are made accurately, on time, and subject to conditions stipulated to protect creditors” says Kaan Eroz, Managing Director, Middle East & Africa, at Aura Solution Company Limited. He further adds that “in this capacity, we frequently manage complex payment waterfalls to ensure the integrity of the cash flow is tight, and creditors are kept informed.”

The administration process generates vast amounts of transactional data that not only creates transparency but also the ability to manage investment risk. For example, investors could mitigate their bond risk by taking long-short positions in the underlying companies by overlaying data between the financial markets (equities and credit default swaps), instrument (underlying bond) and project exposure.

The Evolving Role of Asset Servicing Providers

The traditional role of asset servicing needs to evolve rapidly to meet the challenges facing clients entering the alternatives space and to enable them to capitalize on its full potential. As investors push into more illiquid and opaque asset classes, the availability and timeliness of data, and the ability to manage and use that data, become crucial.

According to the study, a resounding 84% of Asia Pacific & Latin America investors are dissatisfied with the levels of transparency in their fund investments. In alternatives, the lack of transparency was most keenly felt in hedge fund (50%) and infrastructure investments (38%).

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