by Kush Gupta

April 8, 2019

What is Private Debt?

Private debt is the debt accumulated by private companies in forms of corporate bonds, business loans or non-convertible debentures. It involves the lending activity carried out by entities other than banks such as NBFCs, High Net Worth Individuals, Debt Funds and Institutions.

Only recently been conferred the status of an asset class in its own right, private debt has been one of the biggest success stories to emerge in recent financial history.

“As a diversification play, private debt is perceived as having superior protections vs. traditional bonds and equity-like returns. It is a less risky way to play PE where investors get a more favorable part of the companies’ capital structure.”

Growth Analysis

In the aftermath of the 2008 financial crisis, bank lending declined as there was a need to rebuild their balance sheets. Meanwhile mid-level companies needed fresh capital to refinance their existing loans and fund their business growth. Institutional and private investors stepped up, attracted by high yields and low correlation with other asset classes, met this real demand and filled the vacuum; thereby fueling growth of the private debt market.

Another factor for sudden growth are pension funds. Defined-benefit pension funds in many parts of the world are facing a massive liability gap—the difference between their assets and what they owe. Many factors have propped open the liability gap, though most pension funds have a sizable exposure to equities, many suffered heavy losses at the time of the downturn and did not reallocate with sufficient precision to reap benefits of the bull run. This liability gap remains a powerful incentive for investors to seek outsized returns. Optimally positioned at the center of the risk-return spectrum, private debt became a preferred choice for these cash-rich funds.

This growth has been nothing short of phenomenal and the sentiment towards it is extremely favorable. In India, successful implementation of the Insolvency & Bankruptcy Code (IBC), RBI’s large borrowing framework for enhancing credit supply, SEBI’s bond market push for large borrowers and increasing acceptability of innovation and complexity of investors should lead to more diverse issuers which would engender the deeper market.

Indian banks are overwhelmed with non-performing loans, making private debt a seemingly better alternative to banks.

Rs. 4.57 Lakh Crores

raised through private placement of corporate bonds, during the first 10 months of the current fiscal year, to meet business needs.

How to Invest?

Private debt investments can be made in numerous forms and pursue a wide range of strategies with different risk-return profiles. The most popular way of investing has been via Debt Mutual Funds (MFs) where the NAV would reflect the investors’ gain/loss.

Lately corporates have been lining up primary issues to raise debt where an investor can subscribe and invest in debt instruments with various tenures and returns. Previously, such issues saw participation only from institutions but with higher inclusion, while individual investors seeking higher yields are capitalizing on these opportunities.

More avid investors seeking higher and concentrated returns, now have access to Debt Portfolio Management Service (PMS) where a portfolio manager buys NCDs and bonds on behalf of investors. They are cost effective and more transparent than mutual funds where the average investor is not aware of fund asset allocation, specific attributes and risk exposure.

Avg. 3-Year Returns %

Why Private Debt?

Returns: Private debt provides high absolute risk-adjusted returns. It is positioned right at the center of traditional debt and equity in terms of returns. Equity markets tend to have a bear phase now and then, which significantly erodes capital. For investors seeking capital protection from assets other than fixed deposits, private debt provides a great opportunity to diversify equity risk and beat traditional debt.

Transformation: With growing demand and supply, new strategies emerge among fund managers as they seek to meet investor needs and requirements. We’ll continue to see innovations in this space. Managers are also finding ways to help investors meet the desire to keep their capital invested while offering a greater degree of liquidity than is available in traditional closed-ended, fixed-life funds.

Diversification: For investors, part of the attraction of private debt market is the breadth of options now available to them. The variety of different private debt strategies such as funds targeting real estate, infrastructure, collateralized loan obligations (CLOs), mortgages or other more specialized areas such as energy or asset-based loans (ABL), provides investors with a wealth of choices and a variety of risk-return profiles.

1,955

new issuances in the first months of the current financial year.

Rs.27 Lakh Crores

corporate bond outstanding at the end of FY 2018, an increase of ~ 1.36 times from March 2016.

Rs.55-60 Lakh Crores

CRISIL’s expected size of corporate bond market by 2023.

Growth Drivers

Retirement Subscriptions: Demand for retirement solutions has been on a constant rise – subsequently absorbing a steady supply of fresh debt that hits the market. Retirees are no longer happy with fixed deposit returns and higher yields in private debt are being favored over traditional investment options.

Increasing Wealth of HNIs: High Net Worth Individuals with goals of wealth preservation prefer steady returns with capital protection. Private debt meets their requirement of avoiding risky equity plays and yet achieving a double-digit return on their portfolio. It also provides them with an opportunity to take exposure in various industries where returns on equity are challenged by high valuations.

Growth in Corporate Investments: CRISIL estimates that capital intensive non-infra companies such as Steel, Cement, Oil and Gas and Auto will require ~Rs.2.5-3.5 Lakh Crores in the next 5 years. Financial sector (NBFCs) is poised to grow at 13-15% CAGR. Infrastructure is expected to attract the highest levels of investment from private debt funds within the next two years with a total capex of Rs.55 Lakh Crores. India’s corporate sector is hungry for growth and traditional banking channels will not be able to meet this funding requirement.

Government Policies: For India to see rapid economic growth in the long term, which is an absolute necessity, the corporate bond market will have to play a pivotal role as a funding source. The government on its part has been very progressive in accelerating growth by a slew of reforms to liberalize, regulate and enhance the industry. Moreover, development of market infrastructure, creation of secondary market liquidity and facilitating expansion of the issuer base have paved the way to broaden the market.

SEBI guidelines require large listed companies to raise at least 25 per cent of their long-term borrowing through corporate bonds, which is to come into force from April 1, 2019.

Deeper Penetration of Financial Products: Indian households have traditionally favored real estate, fixed deposits and gold with 80% of their savings portfolio consisting of these three assets. India fares poorly in terms of financial markets penetration. As a result of rising income, a young working population and policy support – financial literacy is increasing, contributing to inflow of investments in the equity and debt space.

References:

• ICGreport on Rise of Private Debt
• BNY Mellon : Race for Assets
• Intertrust Survey on Global Private Debt market in 2018.
• CRISIL’s yearbook on Indian Debt Market 2018
• https://bit.ly/2Us9g4q (News)
• https://bit.ly/2K50zZJ (News)

About the Author – Kush Gupta

Kush Gupta is a Registered Investment Advisor with SEBI. He currently serves as the head of Financial Markets division in Investments2Go. He has over 14 years of experience in Financial Markets, Financial Planning, Need Analysis and Suitability Profiling; with a command over investment products from various asset classes. His forte is Fixed Income Strategies and is a strategic advisor to treasury departments of various corporates.

Kush holds an Honors Degree in Commerce from Delhi University and a Diploma in Strategic Business Management from Kings College, London. He is currently pursuing CFP (Certified Financial Planner) from Financial Planning Standards Board India. You can reach him at kush@investments2go.com.