In a world without private credit, promoters would have had to forego equity and probably even lose control of their companies. The credit option saves them from an equity investor looking to wrest control. Non-equity dilution for funding needs ensures a higher retention of equity with promoters and current shareholders.
That’s the reason the private credit market ballooned to $10 billion as of 2024, according to a PWC report, ‘Tapping private credit opportunities in India’.
A-rated corporations’ transition to D (default grade) has fallen to 0.86% (2013-23) vs 1.9% (2007-17), according to Crisil and Icra, indicating a better risk-reward for investors.
Domestic investors’ rising appetite
Earlier, only foreign funds would chase such deals, but now domestic capital is aiding their growth with the rise of AIFs (alternative investment funds), structured as Category II AIF investments, governed by the Securities and Exchange Board of India (Sebi).
The pool of capital and structures available in private credit has expanded to meet diverse funding needs through flexibility on tenure, structure, and repayment schedules. Given the flexibility and the nature of capital they bring in, high-net-worth and ultra-high-net-worth investors can invest in the market.
The risk premium in equities has come down, and with performing credit in the private market offering around 5% risk premium, it makes for a compelling proposition for HNIs to invest.
Given that the targeted returns of 12-16% per annum are in line with long-term equity returns and higher than conventional fixed income returns, HNIs and UHNIs are taking a greater interest in the search for higher yields.
Besides, the tax changes have essentially put debt mutual funds and AIFs on equal footing.
High-risk, high-return strategy
Even in a stress scenario, a portfolio yielding 15% per annum with a 10% default rate in the middle of a four-year fund and a 25% recovery rate results in a net yield of more than 12% per annum. Hence, adequate diversification, along with a well-experienced team to help investors navigate the complex set of structures and opportunities, will be vital for investors to reap the benefits of this asset class.
While these funds can offer higher yields than regular debt investment products, risks are also higher. Like any credit risk strategy, there are default risks, which may be higher in challenging conditions. The security taken by the AIF, whether through hard collateral, promoter’s personal guarantee, etc., can help with recovery, but still, credit risks cannot be wished away.
An AIF structure allows the asset manager to create a diversified portfolio in a pooled fund to mitigate some of these risks. Investors also prefer such structures. AIFs have seen a sharp increase with a compounded annual growth rate (CAGR) of around 32% from 2018-19 to 2023-24. This growth has been largely led by Category II AIFs, which account for around 80% of the total commitments into AIFs as of 2023-24.
The private credit market is projected to increase to approximately $58.3 billion by 2028, according to EY.
Views are personal.
The author is the chief executive officer of Equirus Credence Family Office.
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