The Rise of Private Credit Funds in India

Private credit funds are becoming increasingly popular in India, both as a source of capital for borrowers of varying sizes and needs and as an investment opportunity for lenders. With traditional capital sources undergoing a slump amidst macroeconomic woes, private credit funds are poised to be a promising alternative for many reasons.

As per a study by Ernst & Young, private credit activity in India continues to grow at a phenomenal rate, with a minimum of over USD 4 billion invested across select transactions during the first half of 2023.

In this article, we will look at what private credit funds are, how and why they’re emerging as lucrative debt investments, and how investors must look at them.

What are Private Credit Funds?

Private credit funds refer to pools of invested capital that are actively managed by fund managers, and invested in startups and early-stage companies by way of debt financing.

Private credit funds are quite different from traditional debt financing avenues. Firstly, private credit funds offer debt financing to privately held companies, this is an alternate and more traditional credit pathway than the traditional debt market, composed of banks and NBFCs.

Loans are typically offered by private credit funds at a higher interest rate, compared to banks. Additionally, in most cases, such loans are secured in nature. These loans are offered for a pre-decided time period over which the borrower agrees to repay the interest accrued and the principal amount.

Why are Private Credit Funds Becoming Popular as a Capital Source?

Private credit funds are beneficial to both the investors or lenders and the borrowers. For borrowers, the terms are often much more flexible than those of traditional banks and NBFCs. This gives businesses the flexibility to use their debt capital as they wish, within broad terms. For lenders, there is a prospect of earning higher returns and traditional credit intermediaries (banks, NBFCs) are cut out.

Funding to Indian startups is currently experiencing a major slump. Funding tanked by about 77 percent in the period of January to July 2023 compared to the same period last year. Additionally, the flow of foreign investments in Indian startups is also witnessing a decline. While 2021 witnessed over 34 startups attaining a billion-dollar valuation and becoming unicorns, no new unicorn emerged in the first half of 2023, owing to the “funding winter”.

As a result of the funding winter, startups and early-stage companies are now looking for alternative sources of capital, that can offer large capital with as low restrictions as possible. This is where private credit funds come in as an alternative source of capital.

The year 2022 saw record-high levels of private credit transactions in India. Overall private credit transactions reached an all-time high of USD 3.85 billion in 2022, 47 per cent higher compared to the year 2021, as per a study by Ernst & Young.

Now let’s understand how private credit funds are emerging as one of the most lucrative debt investment opportunities at the moment.

Why are Private Credit Funds Becoming Popular as a Debt Investment Opportunity?

As mentioned in the previous section, private credit funds are equally lucrative for investors seeking to invest in debt investments. While traditionally, debt investments are associated with lower returns and lower risk, private credit funds offer a rare mix of comparatively high returns with low risk from a debt instrument.

Additionally, traditional debt instruments like debt mutual funds are witnessing a net outflow, as tax benefits such as indexation benefits were removed. Tax treatment for fixed-income investments has been equalised as a result of the elimination of such benefits. As a result, debt investors are now looking for alternatives that can offer higher returns in the long term.

Ernst & Young's study suggests that there has been an increased interest from family offices, and High-Net-Worth Individuals (HNIs) in investing in private credit funds.

Pertinently, Non-Performing Assets (NPAs) with commercial banks are at historical lows. Further, regulatory changes such as the implementation of the IBC have increased the resolution of distressed assets. All these factors have contributed to overall credit growth in India and boosted the confidence of debt investors. Several private credit funds are being launched in India, with both domestic and foreign players looking to make the most of this funding avenue.

The private credit funds market in India is a highly regulated space, which contributed to investor confidence and trust. Private credit funds are registered with the Securities and Exchange Board of India (SEBI) and are regulated under the SEBI (Alternative Investment Funds) Regulations, 2012. The first half of 2022 saw over 7 private credit funds getting registered with SEBI.

Participation of Investors in Private Credit Funds

Even though the private credit funds market in India is still in its nascent stage with funds getting registered every now and then, this avenue provides a great alternative for investors to diversify their debt investment portfolio.

India’s private credit funds market is already witnessing an increased interest from ultra-high-net-worth individuals and high-net-worth individuals. Investors can invest in the private credit market by investing in private credit funds, just like how Alternative Investment Funds (AIFs) operate. Private credit funds are adopting innovative strategies to offer investors low-risk, high-reward investment opportunities. However, these funds are often out of reach for average investors considering their high ticket sizes.

If you wish to explore debt investment opportunities as a retail investor, you can check out peer-to-peer (P2P) lending, which is yet another high-yield debt alternative that has gained prominence in recent years. The P2P lending market in India is regulated by the Reserve Bank of India (RBI) and is expected to reach a USD 10.5 billion market size by 2026, growing at a CAGR of 21.6% during the 2021-2026 period.

As an investor, you need to ensure that you are choosing your private credit funds or any other debt investments based on your financial goals, and risk appetite. You need to examine the track record of the funds, the fund managers, and the reliability of the fund houses. Being an evolving space, it is always advisable to consult your financial advisor before making an investment decision.

Conclusion

Globally, the private credit industry stands at a whooping USD 1.5 trillion market size. Moody’s estimates suggest that the size of the private debt market grew from about USD 300 billion in 2010, to about USD 1.2 trillion in 2021. In India, 2022 witnessed private credit transactions reaching an all-time high of USD 3.85 billion, while the first half of 2023 surpassed over USD 4 billion in private credit transactions. This momentum is likely to continue in the coming years with increasing participation from retail investors and new funds getting registered with SEBI. As an investor, you need to be aware of how this debt investment avenue is evolving and how you can benefit from the same.