avendus: As debt yields decline, Avendus Finance explains why private credit funds work

avendus: As debt yields decline, Avendus Finance explains why private credit funds work

NEW DELHI: For investors in Indian debt markets, the past two years have been marked by an increasingly elusive search for yield in a regime of low interest rates and record excess liquidity in the system banking.

One area that has benefited greatly from the search for more lucrative returns is the private credit space, including alternative investment funds.

In an interview with, Nilesh Dhedhi, Head of Structured Credit, Avendus Finance, explains how the NBFC crisis following the collapse of IL&Fs and then the onset of the COVID-19 pandemic led to the move to private credit.

“…debt yields have come down significantly (~4-5%), the allocation that was in that side of debt obviously started to yield a much lower yield in absolute terms. ”

“That’s where private credit gained popularity, which worked in the 11% to 18% IRR type with differentiated strategies, so people naturally gravitated towards the borrowing opportunity, that which might give you a higher return to make up for the very, very low return that people were getting otherwise, and a lot of NBFCs have also started moving towards the fund structure. »

Edited excerpts:

Borrowing costs across the economy are expected to rise. We have a major government borrowing program. We have the prospect of US rate hikes and we have high oil prices. What is the outlook for the private credit market?

Domestic factors, as well as company-related factors, come into play more than global factors. First, companies that typically fall under private credit are generally not very large companies that have export-oriented operations or have multiple businesses that are significantly affected by a macroeconomic or global event.

Second, and more importantly, the particular situation or requirement we respond to is not like a typical long-term bank loan given to businesses for five to seven years.

So to that extent my personal view is because it’s so specific to a situation or a business or a requirement at that time that we haven’t seen private credit, at least for the underlying borrowers, being so affected by global parameters now because they are not dependent on foreign capital. Most of them are not in export-oriented companies that are affected. .

On the fundraising side, which is the supply side – since the industry is growing and in its infancy; many of these types of operations were initially or previously performed by the NBFCS.

Now he is moving towards the AIF private credit fund, a kind of structure. Most gamers have only entered the platform in the past year. Most of the supplies are found in the home market, which are your HNI family offices and perhaps some of the corporate treasures. Now, this segment on the supply side is doing well, because at least two months ago, everything was progressing. There was plenty of cash in the system.

I think this market has been growing steadily and that’s why we see a lot of fundraising in the market. Also, since debt yields have come down significantly (~4-5%), the allocation that was in that side of debt has obviously started to yield a much lower yield in absolute terms.

We saw a natural shift to find new avenues where one could earn a higher rate of interest, and this is where private credit rose in popularity which worked in the IRR type of 11% to 18 % with differentiated strategies so people were naturally gravitating towards the debt opportunity which might give you a higher return to offset the very, very low return that people were getting otherwise and a lot of NBFCs also started to get direct to the structure of the fund.

Subprime debt is also attracting a lot of capital as a new asset class, and similarly in the case of private credit, people are also considering a new asset class.

So I would say those are the factors because of which you see the rise of private credit funds.

What could be the risk factors that are now associated with the AIF space?

So I would still say 80% of players are still new or doing their first fundraiser rather than someone who’s been doing it for a long time so in that way I would say the whole industry itself is a very new industry.

So to compare with the situation three or four years ago since the days of IL&FS, I think it may not be correct because there were not many players. However, what necessitated this switch to a private FIA ​​credit was IL&FS and then obviously the pandemic.

NBFC’s balance sheet transactions made it clear that liquidity was becoming a challenge. Higher leverage is something that people weren’t very comfortable with. Credit rating agencies likely downgraded some of them due to asset quality issues and pandemic-related lockdowns, and all mutual funds were hit after IL&FS, DHFL-like episodes.

They almost moved out of the space where they weren’t lending to any of these structures – lending to NBFCs; the banks have somehow reduced their exposure. Wholesale lending as a whole; they also went into their shell a bit. So there were a lot of supply side issues, and then there were a lot of balance sheet things that would work in a growth scenario.

Additionally, because RBI has become a much more regulatory entity, it was the main driver behind the move to AIF, which was seen as a relatively more flexible structure compared to NBFC loans.

It’s a private fund, it’s a closed fund, isn’t it? It is an unlisted entity. You could therefore offer great flexibility, which you could not otherwise do in a highly regulated environment.

Many things that RBI allows or does not allow banks and NBFC can be done by the fund. So I would say that was the second part of it that naturally the flexibility that this particular product requires from the customers’ perspective, which is probably better given or accommodated in the AIF structure versus the NBFC structure.

Bringing the point to excess liquidity, we can expect the RBI to gradually move away from an excess liquidity regime over the next financial year, which could lead to higher yields and bond yields to some extent. measure. So, do you see more interest from entities such as the HNI?

I would still say yes, for 2-3 reasons. The first is that unlike your traditional dataset or stock assets, if you look at any family or any HNI – say if you have Rs 100 then a lot of them would be mostly on the debt side, right? I mean usually the debt allocation is say Rs 60 and the equity allocation is Rs 40. Now also within that framework usually people gravitate a lot on a personal level towards the FD bank, G- sec bond tax free bond AAA , right. So the safest assets so far have taken almost, I would say 70-80% if not more of the debt allocation itself.

So what are called alternative funds then pooled, of course, credit funds, very short-term funds, bond funds, which give you a return of 7%, 8%.

Now anything outside of that category from FDs to credit to mutual funds to bond mutual funds which are 4% to 8% you will see virtually no investment opportunity or you will hardly see any demand from investors.

So what we used to call alternative debt; the alternative investments category then, on the equities side, people who are very comfortable with listed equities. Within that, of course, let’s say Sensex will be at 60%, then mid caps and other things. This way the allocation was very clear now with regards to wealth, the wealth of the HNI as a whole in India or in any particular segment is not going down because they would have invested in something or even if they don’t haven’t invested in something that has grown, they have their own business.

The people on the corporate side who have survived this pandemic are only getting bigger and bigger and obviously getting a higher valuation. Many companies become unicorns, many companies are sold, many promoters get cash.

I think that part is still intact, and it’s growing. However, the biggest push will come when the asset allocation changes.

I agree with you that in the future there may not be as much cash. So maybe before, if you put in Rs 100, it became Rs 120 in six months, became 130 in one year; that kind of returns may not be available but if 100 becomes 110, the alternative product allocation, which used to be, let’s say less than 5%, even if it becomes 10%, then you open up a huge potential investment who could return.

The Avendus two credit fund is estimated to offer a yield of 16-18% depending on price lock and duration. Are you on track to achieve this goal and what are the growth prospects for the next fiscal year?

So this is our second fund; just to give some context, we created our first fund four years ago which almost went out, as you know, probably eight out of nine trades went out.

We took over 120% of the capital and this fund, on a gross portfolio basis, generated a return of approximately 18%. The second fund we are talking about is still in the fundraising phase. We completed two closes and reached 65-70% of our target size. So we made some investments and this fund over a period of 1 to 1.5 years, we will make another 10 to 12 investments. At the portfolio level where we are aiming for 16% to 18%.

Our feeling is that we should be able to find another eight to ten trades that will provide this return, as we did for 10 trades in the first fund.