Performing Credit Funds have been the flavour of the season of late and much has been talked about the promise of this asset class and the expectations of it delivering superior risk-adjusted returns in the coming years. The expected muted earnings in public equity markets, coupled with the fact that duration as a strategy in fixed income is not expected to play out as anticipated, make the moderate-risk accrual strategy an attractive proposition going forward, and it should find a place of pride in investors’ portfolios.
As was the case with infrastructure, real estate, and NBFCs in the last two decades, whenever a sector demonstrates promise, it attracts players of all shapes and forms. But as the dust settles over the initial euphoria, the sector matures and consolidates, with a few large players dominating the landscape.
Invariably, an accident matures a sector, and it is only to be expected that this asset class will also face its challenges concerning asset quality, low returns, and the consequent souring of investor sentiment. It is probably an opportune time to analyse the attributes that will drive the creation of a successful franchise.
As the multitude of players attracted to the sector play out their balance in growth, risk, and return aspects in their respective portfolio offerings, invariably, risk or return may get compromised in the pursuit of growth.
The likely softening of the credit cycle and its consequent impact on some of the in-vogue sectors like BFSI, venture debt, sponsor/holdco leverage, etc., in several performing credit portfolios may further accentuate the asset quality challenges. In the last few years, the buoyancy of the public equity markets enabled other asset classes to appear more attractive, and especially weak credit profile companies were able to raise cheap equity capital to avoid funding mismatches. The likely lack of a “risk-on” sentiment in public equity markets will have a rub-off impact on crossover credits as sentiment mutes their fundraising ability. The resultant subpar portfolio returns, and the current “me-too” nature of several asset aggregator portfolios may impact the risk-return proposition of this asset class in the minds of investors.
In any funded financial intermediation business, akin to an asset-heavy sector, the efficiency of the liability side drives the attractiveness and even viability of the asset-side proposition.
Significant investors in these funds will essentially be domestic institutional investors like insurance companies and corporate treasuries, as this low/moderate-risk, moderated-return asset class fits their risk-return expectations. In-house fundraising channels with existing deep relationships with these institutional investors will drive scale and cost efficiencies in fundraising.
The 12-14% yield segment essentially replaces NBFC corporate lending and plays to themes of proxy senior secured debt to A- to BBB-rated companies, funding enhanced working capital requirements, acquisitions, promoter/financial sponsor buyouts, infrastructure sector debt top-ups, etc., for companies in traditional manufacturing/industrial sectors. This will require fund managers to have a proxy Bank/NBFC-like mindset and team setup to identify clients/lending opportunities and underwrite/manage credit exposures. These portfolios are likely to be diverse and granular, with bank-like risk exposure norms.
These funds will remain low-expense funds, driven by scale, and are likely to be dominated by existing large AMCs and select distributor-run platforms. These players can achieve significant scale within their investor universe, as low distribution expenses will enable them to keep their fund management expenses to investors low, with no performance fees. The performing credit fund space is less than 5 years old, and most fund managers do not yet have a substantial track record, given the infancy of the sector. As of now, investors are still investing in the asset class due to its attractiveness. As the segment matures, differentiation in performance will drive investment in the funds and will also result in the evolution of sectoral funds, theme-based funds, etc.
Credit as an asset class is institutional in nature, and the pedigree and track record of the investment manager and fund house are invariably differentiating factors in institutionalizing aspects of deal origination, transaction structuring, credit underwriting, and portfolio asset management. This institutional approach toward client relationships and risk management enables the creation of a diverse, granular portfolio, giving appropriate risk-adjusted returns via bespoke and unique transactions. This will be the key differentiating factor for the creation of a sustainable platform.
Credit is as old as the corporate sector, and while credit can create an economy, the lack of credit can quickly destroy it. It is imperative that we don’t just get this segment right, but also that we don’t get it wrong. It’s probably time to play this game as a test match, not a T20, and bring to the fore Dad’s mature acumen in creating long-term sustainable value, rather than the Son’s urgency to create overnight valuation.
