“There are decades when nothing happens and there are weeks (rather years in this case) when decades happen” – This quote by Vladimir Lenin, seemed apt for Indian private credit market in 2023. In many ways CY23 has been a pivotal year wherein industry witnessed a significant activity wherein over ~$3.5bn1 was estimated to be raised via commitments by various private credit AIFs in this space.
For an industry which was taking baby steps in this space, two fundamental parameters were at play which in our view will pave way for industry to witness sustained strong growth in medium to long term. Firstly, CY23 witnessed various taxation related announcements on the debt front. With all debt products coming at par in terms of taxation, there was increasing investor interest towards private credit strategies as they offer a better risk reward proposition and a potential for alpha generation for sophisticated investors. Also, post the global meltdown, IL&FS event and the pandemic, the focus of credit market had shifted to traditional products such as bank debt, NCDs with higher credit rating etc. Even NBFCs had vacated the credit space, which led to a void and as a result private credit funds emerged as an important financing option
What & Where about Structured Credit Strategy
This category has varied yields(gross) which start from 12% and go right up to 18-20%, higher return is of course accompanied with high risk3. Generally, funds backed by institutions prefer participating in the lower end of the performing credit yield curve (typically 12-14%)4. The opportunities which these funds can typically invest in are primarily on account of the end use restriction as per regulations with respect to certain situations which a bank cannot fund. In such scenarios a company or promoter (which generally borrows at relatively low interest rates from banks) is willing to offer relatively higher yield or borrow at a higher rate due to specific requirements such as funding of working capital for higher growth, exit to be provided to certain non-promoter shareholders, growth capex, merger/acquisition opportunities etc.
Past Performance may or may not be sustained in the future. This above trend is historical and may or may not continue. Source: IVCA. Data are given till December 2022.
Investment activity in this space has seen a surge as indicated by the deal activity trend.
In first half of 2023, more than ~$2bn2 was raised by global and domestic funds, with a mix of sector-specific (real estate, pharma, manufacturing, etc.) and sector agnostic approach to performing credit, stressed credit and special situation opportunities. Even the deployment activity remained strong wherein in just first half of CY2023, ~$4bn2 was deployed.
With expected growth in economy and revival in private capex we anticipate strong momentum to continue in terms of deals flow in private credit market as requirement of solution capital to address few of the situations discussed above would keep growing in medium term.
Moving from macro to micro we have witnessed significant improvement in financial leverage and debt protection parameters of both corporates and financiers. Further generally the interest rates are higher in the economy post multiple rate hikes by central bank in past few years. Combination of all these parameters results in favourable medium-term outlook for private credit-oriented strategies.
Here to stay!
The recent gush of interest in credit AIFs does not look a transient trend, in fact it is more like a response to a genuine need in the Indian market, led by both demand and supply factors. Even the funding winter and economic uncertainty, wherein companies found it difficult to borrow from markets, opened doors for non-traditional sources of financing, like private credit. In the global financial markets such products have been there for decades, however, these are relatively new to India. The E&Y report3 mentions that the performing credit opportunity in India could range from $39 billion to $89 billion over the next five years, with real estate, infrastructure, and consumer lending sectors showing promise. In fact, these strategies could be instrumental in broadening the Indian debt market. As the industry continues to evolve and alter as per the changing financial and investment landscape, the future seems to be promising.
What to look for while choosing this category
While the category looks promising for the next few years, it is important to analyse a few factors before choosing a fund. These factors can range from an asset manager’s expertise on the credit platform, track record in capital preservation especially in periods with difficult credit environment and overall risk management philosophy. Considering the low liquidity associated with credit-oriented exposures it is extremely important for investors to comprehensively evaluate the 4Ps i.e. Pedigree of Investment manager, Process, People and Portfolio in order to take an informed decision.
