– By Arihant Bardia
In the world of finance, change often comes when traditional players are preoccupied with their own strategies. That’s precisely what’s happening right now. Banks are laser-focused on reducing their Non-Performing Assets (NPA), which means they’re inclined to invest in safer, higher-rated products. This shift is evident in the changing composition of Banks’ Asset Under Management (AUM). They’ve reduced lending to industries while increasing consumer and personal loans. This shift leaves a void for invested grade by relatively lower-rated companies that need loans. Additionally, Non-Banking Financial Companies (NBFCs) have also shifted their focus away from these companies, leaving gaps in the market. This is where Alternative Investment Funds (AIFs) step in.
AIFs come to the rescue by offering loans to lower-rated and non-rated companies at interest rates ranging from 12% to 18% with the riskiest credits going up to 20% to 24%. At times, these credits have an equity kicker or an upside warrant, to further enhance the yields. AIFs have become a popular choice for businesses, especially those who are unable to raise funds from banking channels. AIFs not only enjoy the flexibility to structure but also do not have the regulations restrictions that are placed on Banks and some NBFCs. Moreover AIFs are able to conclude transactions in less time frame compared to Banks.
To make things even more interesting, the removal of indexation benefits from debt mutual funds in 2023 has cast a shadow over traditional debt products. Savvy investors hunting for higher returns are now flocking to structured debt products offered by a variety of AIFs. Instead of parking their capital in foreign banks and global funds, they’re placing their bets on AIFs, which are rapidly gaining ground. Notably, AIFs are no longer limited to High Net Worth Individuals (HNIs); they’ve also become a preferred investment choice for insurance companies, corporate treasuries, and family offices. Projections indicate that AIF AUM will soar at an impressive 11.5% CAGR over the next five years, surging from $13 trillion to $23 trillion. This growth underscores that private equity and private debt are set to become the fastest-growing asset classes. Presently, private credit addresses around 30% of the market opportunity size, estimated at $7 billion in 2022.
In contrast, the Mutual Fund industry, which once had substantial exposure to credit schemes, has drastically scaled back its credit investments. As of March 2022, AUM in Mutual Funds’ credit schemes has plummeted by a staggering 68% from its peak in August 2018.
Mutual fund AUM in credit schemes:
Now, does this remarkable ascent of AIFs spell doom for traditional lenders? Not necessarily. With the Indian economy on an upward trajectory, the demand for capital by companies is poised to skyrocket. This burgeoning need will create opportunities for NBFCs, banks, and AIFs to coexist and cater to their distinct markets. It’s worth noting that AIFs have also left an indelible mark on the unorganized private lending sector, once dominated by ultra-HNIs and corporate promoters. Through improved structuring, diversification and legal avenues available to AIFs, private lenders have increasingly become investors in these AIFs.
In the past year, over 50 companies have filed for an IPO, and the slow equity market has affected IPO certainty and valuations. Economic uncertainty has opened doors for non-traditional sources of financing, like private credit. This vacuum has given AIFs a strong start. As of March 31, 2022, AIFs had raised commitments of Rs 6.4 lakh crore, a sevenfold increase in the past five years. A report by EY estimates 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.
However, like any investment, AIFs carry their share of risks, including potential mis-selling and over-concentration of funds in specific categories like real estate or infrastructure. Investors should also be prepared for longer lock-in periods. While these challenges are par for the course in the investment world, a comprehensive evaluation of the “Three P’s” – People, Process, and Portfolio – is essential before committing capital to credit AIFs.
In summation, the recent surge of interest in credit AIFs is not a fleeting trend but a response to a genuine need in the Indian market, driven by both supply and demand factors. AIFs represent a relatively new asset class in India, unlike in more mature global financial markets where similar products have thrived for decades. The future is indeed promising as they continue to evolve and adapt to the ever-changing financial landscape in India.
(Arihant Bardia is the CIO and Founder of Valtrust.)
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