Vineet Sukumar, Founder and MD of Vivriti Asset Management, 0
How do you expect the Indian private credit scenario to pan out in the coming years?
The opportunities for private credit in India emanate from structural issues in its debt market causing a funding gap. Following the global financial crisis, the banking sector became increasingly risk averse towards the mid-corporate space. Since 2018-19, asset managers have sharply cut down their allocations to the segment following credit defaults while non-bank lenders largely migrated to retail credit after facing a liquidity crunch.
However, demand for loans keeps growing in the mid-market corporate space due to inherent strength in the economy. India is expected to be the fastest-growing major economy this fiscal year with an estimated seven percent growth and is on track to become the 3rd largest economy by 2030. Given these factors, when we compare India’s private credit market with overseas markets, we foresee a huge headroom for growth. India’s private credit AUM accounts for <0.5 percent of its GDP while in Europe and the US, the ratio stands at 1.7 percent and 3.1 percent, respectively.
India has 15,000 mid-market enterprises that seek to borrow around $75 billion annually. However, their access to both term loans and debt capital markets remains low. With the restart of the capex cycle, debottlenecking of receivables, as well as higher ambition in the corporate sector, we see tremendous potential in the “High-grade Performing Credit” space. We believe that this space will be the fastest growing within Private Credit.
What trends do you foresee in Asset Management, specifically with private credit AIFs for the mid-market?
The momentum for AIFs in the private credit market in India is expected to continue in their second decade of existence. Debt fund managers in the space are looking at a potential window of opportunity both on the asset side and the liability side.
On the asset side, AIFs have become increasingly visible to mid-market entrepreneurs and treasuries that seek debt for growth. AIFs offer flexibility, tenure, size, and risk appetite, while seeking higher standards of governance and disclosure from their portfolio companies. Ambitious enterprises have sought to capitalize on this to accelerate their growth and build scale in an environment where India is leading the world on growth.
On the liability side, ultra-high networth and sophisticated investors looking for superior risk-adjusted returns are increasingly allocating their funds to structured debt products and Performing Credit funds offered by AIFs instead of parking their capital in traditional avenues. Investments in debt AIFs not only offer them diversification but save them from the pain of individual monitoring in direct investments by depending on professional diligence and monitoring practices of efficient fund houses. Apart from HNIs, these factors turned AIFs to be a preferred investment choice for insurance companies, corporate treasuries, and family offices as well.
In what ways do traditional financing options fall short for mid-market players, causing a funding bottleneck, and how can this be tackled?
There is an asymmetry in the credit market and mispricing of risks leading to lower growth in lending to companies with a credit rating of A and below compared to the entities in the higher rating bracket. Banks have little incentive to take the higher risk that is associated with term finance, and instead make healthy margins by providing secured working capital finance. Mutual funds have retreated to AA/AAA category since 2018.
To tackle this bottleneck, the market requires specialized players that use digital data, smart acquisition, and in-depth underwriting to deconstruct the balance sheets and business models of unlisted mid-market enterprises. Further it is important for entrepreneurs and promoters to invest in governance, systems, and disclosure, to be able to access such pools of capital and meet the compliance requirements associated with a capital market issuance. For too long, mid-market enterprise ecosystem has depended nearly solely on equity for growth. With availability of moderate term debt, their growth path could change drastically.
What are the nuances of investing in the Performing Credit segment in the private credit market?
In a risk-return spectrum, the Performing Credit (PC) segment depicts the white space between the (i) low-yield, high-rated space occupied by debt mutual funds and (ii) high-risk space favored by the special situation, distressed, and venture debt funds. Considering the life-cycle stages of a corporation, entities in the PC space are typically in the growth stage, as opposed to early-stage entities preferred by venture debt firms or mature and late-stage companies that find themselves in distress or need situational funding. The PC space typically yields 8 – 16 percent gross returns and offers superior risk-adjusted returns.
The borrowing entities in the PC space are profitable and operating companies with visible cashflows; proven and stable business models; over three years of vintage; and a revenue range of INR 300 to 4000 crores. They are typically moderately rated (A to BB). Forming the essential middle range of entities that ensure a robust economy, these entities are predominantly well discovered by the banking system.
Choosing a highly professional fund manager is extremely useful while investing in the high-grade PC space. Investors should look at fund managers who leave no stone unturned for strict due diligence, comprehensive business monitoring to reduce information asymmetry, excellent sourcing ability, tight quarterly monitoring, and accurate pricing of risks, among other factors.
What's your perspective on regulations deepening the corporate bond market and making credit AIFs more investor-friendly?
Deepening the bond market addresses the problem of giving lower-rated issuers access to cheaper sources of funding who are otherwise dependent on bank funding. Indian regulators have taken a lot of steps to enhance participation in the corporate bond market and to widen the issuer and investor base. However, bond markets have remained shallow, and India’s corporate bond market lags its Asian peers.
To make bond markets vibrant and deeper, it is vital to see an increase in allocation of household savings to the lower rated bond market. The best and most suitable way to do this would be to encourage “pooling of assets” into specialized vehicles managed by fund managers that understand this risk. Pooling reduces risk on account of diversification, while asset selection is much better with a professional manager.
Therefore, it is important to (a) propagate and promote more credit AIFs to develop, (b) use accreditation widely to ensure suitability of marketing efforts, (c) actively promote listing of AIFs to build liquidity and reduce investor risk, (d) use tools such as capital protection credit ratings, asset valuation, and fund audits to bring transparency.
To tackle this bottleneck, the market requires specialized players that use digital data, smart acquisition, and in-depth underwriting to deconstruct the balance sheets and business models of unlisted mid-market enterprises. Further it is important for entrepreneurs and promoters to invest in governance, systems, and disclosure, to be able to access such pools of capital and meet the compliance requirements associated with a capital market issuance. For too long, mid-market enterprise ecosystem has depended nearly solely on equity for growth. With availability of moderate term debt, their growth path could change drastically.
To make bond markets vibrant and deeper, it is vital to see an increase in allocation of household savings to the lower rated bond market.
What are the nuances of investing in the Performing Credit segment in the private credit market?
In a risk-return spectrum, the Performing Credit (PC) segment depicts the white space between the (i) low-yield, high-rated space occupied by debt mutual funds and (ii) high-risk space favored by the special situation, distressed, and venture debt funds. Considering the life-cycle stages of a corporation, entities in the PC space are typically in the growth stage, as opposed to early-stage entities preferred by venture debt firms or mature and late-stage companies that find themselves in distress or need situational funding. The PC space typically yields 8 – 16 percent gross returns and offers superior risk-adjusted returns.
The borrowing entities in the PC space are profitable and operating companies with visible cashflows; proven and stable business models; over three years of vintage; and a revenue range of INR 300 to 4000 crores. They are typically moderately rated (A to BB). Forming the essential middle range of entities that ensure a robust economy, these entities are predominantly well discovered by the banking system.
Choosing a highly professional fund manager is extremely useful while investing in the high-grade PC space. Investors should look at fund managers who leave no stone unturned for strict due diligence, comprehensive business monitoring to reduce information asymmetry, excellent sourcing ability, tight quarterly monitoring, and accurate pricing of risks, among other factors.
What's your perspective on regulations deepening the corporate bond market and making credit AIFs more investor-friendly?
Deepening the bond market addresses the problem of giving lower-rated issuers access to cheaper sources of funding who are otherwise dependent on bank funding. Indian regulators have taken a lot of steps to enhance participation in the corporate bond market and to widen the issuer and investor base. However, bond markets have remained shallow, and India’s corporate bond market lags its Asian peers.
To make bond markets vibrant and deeper, it is vital to see an increase in allocation of household savings to the lower rated bond market. The best and most suitable way to do this would be to encourage “pooling of assets” into specialized vehicles managed by fund managers that understand this risk. Pooling reduces risk on account of diversification, while asset selection is much better with a professional manager.
Therefore, it is important to (a) propagate and promote more credit AIFs to develop, (b) use accreditation widely to ensure suitability of marketing efforts, (c) actively promote listing of AIFs to build liquidity and reduce investor risk, (d) use tools such as capital protection credit ratings, asset valuation, and fund audits to bring transparency.