AIFs find sweet spot in private credit with change in taxation of debt MFs

Unfulfilled credit demand in riskier segments, lack of high-yielding options create opportunities

The private credit alternative investment fund (AIF) space is witnessing heightened action this financial year (2023-24), with the change in taxation of debt mutual funds (MFs) and market-linked debentures in Budget 2023 providing a strong impetus.

While existing players are targeting growth with newer offerings, some big names in the asset and wealth management space are entering the AIF arena.

Franklin Templeton Asset Management Company (AMC), which was one of the top players in the MF credit space until 2020, is now re-entering the market through AIFs.

US-based private equity behemoth Blackstone-backed ASK Private Wealth made its entry into the private credit AIF space earlier this month with a plan to raise Rs 1,000 crore.

Simultaneously, several existing players like Edelweiss Alternatives, and InCred Asset Management & Alternative Investments are looking to increase the size of such funds or raise new funds, according to reports.

Experts attribute the surging activity in the private credit AIF space to two factors: the gradual exit of non-banking financial companies (NBFCs) and MFs from the riskier credit space after 2018, and the recent change in debt MF taxation, which created a level playing field for all fixed-income products. While the former created demand from the borrower’s side, the tax change has allowed them to reach newer investors.

“In the lending space, banks deal with only traditional transactions with regular interest payments and a defined end-use. Any bespoke, customised solutions are largely being catered to by foreign banks, global funds, and a few NBFCs. Domestic AIFs have been active in this space in the last two/three years,” says Shekhar Daga, head of private capital at ICICI Prudential AMC.

Private credit funds typically invest in the debt of unrated and lower-rated companies. Most recent launches have been in the performing credit space, which generally delivers yields in the range of 10-14 per cent.

Before the tax change, these AIFs would have faced tough competition from debt MF offerings considering the better tax and risk-adjusted returns, observe advisors.
 

However, the growing traction is also making the industry nervous. Executives worry that rising competition and higher yields might lead to mis-selling and concentrated bets by investors lured by high returns.

According to an end-2022 survey by EY India, “Seventy-one per cent of fund managers believed that there is a ‘moderate’ risk in existing private credit portfolios. More than 80 per cent of fund managers continued to be bullish about private credit investment opportunities in India, both in the short and long term.”

BIG BET THEORY

• $5.3 billion Private credit deals in 2022, according to EY India
• 58% Share of global funds in value terms
• 33% Share of domestic funds
• 12%-14% Yields offered by most funds