Asset management companies and wealth advisory firms are pushing into the private credit business in India as high-net-worth investors chase yields, after new tax rules cut into returns from other investments.
Since the start of the financial year in April, five private credit funds have been launched, with flows into such products estimated at Rs95bn (US$1.14bn) in the next three to six months, according to estimates by fund managers.
Until March 31, investor flows were skewed toward debt funds and market-linked debentures because of tax exemptions. The capital gains on debt mutual funds held for more than three years and MLDs held for more than one year were indexed for inflation and benefited from the long-term capital gains rate of 20%.
Starting from April 1, capital gains from debt funds and MLDs are now taxed according to the individual investor's income bracket, cutting into their returns.
"Once the government took away the tax incentive, obviously the [mutual funds] needed to find some other product to go back to their customers to give that kind of return," said Srini Sriniwasan, managing director of Kotak Alternate Asset Managers, which has diversified assets under management of over US$18bn.
Debt funds for bonds rated AA and above were getting returns anywhere from 7%–8% post tax (subject to the portfolio holding and rating of the companies) under the old regime, according to fund managers, but those will now be lower.
Most of the private credit funds launched recently are targeting performing credit, which focuses on profitable mid-size companies, in the yield range of 11% to 14%, giving average post-tax returns in the region of 10%, depending on the end investor's tax bracket. The next segment is special situation funds with pre-tax yields ranging from 14%–18% and distressed credit with yields above 18%, according to Rakshat Kapoor, chief investment officer and fund manager at Modulus Alternatives Investment Managers.
Additional funds continue to be announced, and the sector growth shows no signs of stopping.
Franklin Templeton, for example, is preparing to launch a new private credit fund in the next three to six months, according to sources. The fund house is returning to the credit fund business in India after it shut six debt schemes in April 2020 because of severe redemption pressure amid the pandemic. Santosh Kamath was named president and chief investment officer of Franklin Templeton Alternative Investments India on August 1, after previously serving as managing director and CIO of Franklin Templeton India AMC Fixed Income.
In May, Nippon Life India Asset Management launched a Rs20bn private credit fund, industry sources said.
Meanwhile, ASK Private Wealth, the independent wealth advisory and family office arm of ASK Group, launched its debut private credit fund targeting up to Rs10bn on August 8. The firm has appointed Shantanu Sahai, as senior managing partner and head of the fund. He was previously managing director and head of debt at Nomura India.
ASK’s private credit fund is raising money from 3,500 high-net-worth investors and family offices, all of which are existing clients. It is targeting US$1bn of assets under management in four to five years, and is also aiming to launch an offshore fund in the near future, said Sahai.
"After Blackstone acquired a majority stake in ASK last year, the management embarked on a strategy to offer a diversified portfolio of in-house equity and debt offerings to our clients," Sahai said. ASK managed US$9.98bn in assets as of the end of June.
Sahai estimates private credit deal volume will top Rs350bn this year, with the market set to grow by around 10%–15% annually for the next few years.
Asset managers are launching private credit funds under India's Alternative Investment Fund category II route, which offers benefits "such as an unregulated fee structure, higher corpus of investment (Rs10m), and flexibility for fund managers to invest in rated and unrated paper," said Ankur Jain, managing director of private credit at InCred Alternative Investments.
Some fund houses have already launched their second private credit funds in the past few months to keep up with demand. Axis Asset Management launched its second private credit fund of Rs12.5bn on July 14 under the alternatives portfolio after launching its first in 2021. ICICI Prudential Asset Management launched its second credit alternative investment fund targeting up to Rs40bn on July 3, following its first in 2021. In June, Modulus Alternatives Investment Managers launched a second private credit fund targeting Rs12.5bn, following its first fund in 2019.
Market participants expect Rs1trn of the money that used to chase debt funds and MLDs will move to private credit. "We have accelerated our fund launch by two months because of the tailwinds from the favourable taxation parity in the budget," said Sahai at ASK Private Wealth.
This is happening as big companies acquire smaller companies post-Covid, spurring more demand for private credit. "There is a need for financing buyouts by corporates across the spectrum," Sahai said.
Typically, minority private equity investors exit their holdings through the IPO market, but valuations are not attractive at the moment. "Companies are unable to offer exits to investors via the public equity market, hence they are raising debt at 15%–16% (approximately) so that the minority investors can exit by being bought out by the majority shareholders," said Sahai.
Sweet spot
India is in a sweet spot for private credit as many investors are looking for an alternative to Chinese assets. India's macro environment is stable, with non-performing assets on bank balance sheets at decade lows, corporates making progress in deleveraging, and a massive infrastructure push by the government.
Large companies or those with high ratings can easily raise funds from the bond and loan markets, but private credit funds are financing companies further down the credit curve.
"There is a funding gap of close to US$50bn–$75bn for corporates which are rated A and below and are unable to tap the loan and bond market, of which around 20%–30%, and more, can be easily met from the private credit market," said Kapoor at Modulus.
Credit funds' assets under management dropped significantly after Franklin Templeton shut its credit schemes in 2020, while non-banking financial companies have scaled down their wholesale lending since Infrastructure Leasing & Financial Services defaulted in 2018.
Regulatory oversight has tightened for non-bank lenders and mutual funds over the past few years, making it very difficult for them to lend to lower-rated credits.
However, market participants are flagging the possibility of funds chasing risky credits and making bad investment choices as competition increases.
"Every week, a non-bank lender and mutual fund is setting up a private credit fund of US$150m to US$200m in size from domestic investors, and my experience shows that when too many people jump into it, there are bound to be accidents," said Sriniwasan at Kotak Alternate Asset Managers.