Credit growth in the Indian economy is expected to remain buoyant, driven by focus on manufacturing, economic tailwinds and India being called the next big growth market by foreign equity investors. The private credit funds catering to mid-market corporates will continue to be a notable player in the lending ecosystem due to continued focus of larger banks on established corporates and retail loans, while NBFCs scale back wholesale lending, given the trouble some faced in 2018-19.  

In our estimate, there is a gap of over ₹1,30,000 crore due to wholesale NBFCs, open-ended mutual funds, and some private banks reducing their focus on the mid corporates and financing for growth capital that needs customisation. To address the gap, around ₹40,000 crore of assets have been raised by private credit funds (through AIF route) since 2017, and we expect another ₹15,000-20,000 crore to be raised in the next two years. And yet, the capital raised by AIFs will still fall short of the credit that the economy needs, especially in areas of manufacturing, healthcare and services.   

Private credit funds are gaining traction as a must for family offices and HNI investors as part of a well-diversified fixed income portfolio managed by experienced investment professionals. Every fund operates in a different risk-return segment with net of fees and expenses (but pre tax) offer between 11-18 per cent, which is a substantial pick-up over the risk free alternatives (bank FD and liquid funds). However, the risk profile is very different for funds targeting 11 per cent net return (typically senior secured obligations) vs funds targeting 18 per cent net return (typically venture debt and special situations).

Private credit funds can deploy different investment strategies to deliver the optimal risk-return for its investors. For example, these funds could focus on different stages of the corporate lifecycles. Some funds could focus on the start-up phase, some could come in a little later once the business has gained a certain scale, and some might only look at more established businesses. Then there can also be funds looking at opportunities in stressed businesses. A fund could also use a combination of these strategies. The drawdowns and return of capital could be very different for each fund strategy and, hence, investors should match it with their funds availability and requirement.  

Key considerations

The funds target returns, but they are not guaranteed returns like a bank FD. Investors need to evaluate if the manager has experience in delivering these returns or managing such exposures. Or if a particular manager has an edge in originating and risk managing such positions.  

Granularity is another risk mitigant. Given the upside in private credit funds is more restricted compared to equity funds, the downside protection through individual transaction structuring is very important. In my view, there is equal importance to maintaining granularity and diversifying exposures across companies and sectors.

Averages are misleading. If a fund targeting 13 per cent net return takes exposure to a company at a 20 per cent yield, it could definitely boost returns, but its also adding risk that might not be core to their investment thesis. Or if a private credit fund makes returns on listed equities, it defeats the purpose of investor diversification. As the market matures, investors will dissect the returns and investments made to see if managers stick to their strategy that was discussed while raising funds.  

The future of private credit in India will be shaped by a balance between innovation, regulation, risk management, and the evolving needs of borrowers and investors. Long term success will be achieved by funds who are transparent, disciplined and stick to their investment objective.

Saurabh Jhalaria is CIO, Alternative Credit Strategies, InCred Alternative Investments

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