Traditionally, Indian investors had all their fixed income investments in the open-ended format, with a large portion of Indian savings being invested in bank fixed deposits or government sponsored savings schemes. However, as time progressed, the options widened and now we have wide range of fixed income products available through mutual funds, listed corporate bonds and corporate fixed deposits.
These options catalysed the process of retail money moving into corporate India—a win-win for both corporates and savers. It widened the sources of funding for corporates and in the bargain allowed Indian savers to earn relatively higher fixed income returns. Subsequently, the market expanded further with newer product innovations like market-linked debentures.
Now, private credit has emerged as a new investment category offering investors (particularly high net worth investors) access to well-diversified fixed income portfolios managed by investment professionals. Private credit products are structured as close-ended credit-focused alternate investment funds (AIFs) that could offer 13-20% returns per annum, while locking in investors’ capital for a defined period of time.
In the last five years, the private credit market has evolved exponentially in volume and numbers. The size of category II AIF market (of which private credit funds are a key component) has reached ₹6.96 trillion, up by around 24% on a year-on-year basis.
Debt AIFs function like a fund, where an investor entrusts its savings to a portfolio manager, and the portfolio manager pools savings from various investors and uses that pooled corpus in lending investments on behalf of investors. So, investors in private credit funds get exposure to multiple fixed income investments for the same amount of investment and active portfolio management of those investments.
Private credit funds can deploy different investment strategies to optimize the returns for the investors. For example, these funds could focus on different stages of the corporate life cycles. Some funds could focus on the start-up phase, some could come in a little later once the business has gained a certain scale and some funds might only look at more established businesses. Then there can also be funds looking at opportunities in stressed businesses. A fund could also use a combination of these strategies.
These funds might also decide to lend for certain use-cases. These could be for transaction requirements like mergers and acquisitions or working capital needs or capital expenditure (capex) or special situations where certain investors need to be given exits. These funds could also diversify across businesses and lend to infrastructure assets, real estate assets, financial institutions or other corporates.
Growth potential
Banks’ exposure to the retail segment has increased to 33% and its share of single A minus and above credit has increased to as high as 85%. This leaves a wide white space for private credit funds to fill the gap for lower credit rated corporates. Single A minus is just a notch above investment grade in terms of credit ratings.
With the Indian economy being at the cusp of upswing, financing working capital and capex is the need of the hour, especially for small and medium enterprises and mid-market corporate India. Investors with a relatively large investment corpus might want to look at funds focused on this space for the next three-five year of investment horizon.
But, unlike a traditional fixed deposit or a listed bond where an investor can liquidate the investments relatively quickly, the capital in a private credit fund is invested for a defined period of time and hence has low liquidity. Investors for the invested period may or may not get regular cash flows, and redemption during this period is not permissible. Investors holding till maturity can expect healthy returns from a well-managed private credit fund.
Ankur Jain is managing director of InCred Alternative Investments.
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Updated: 14 Sep 2023, 10:36 PM IST