Semi-liquid funds: A potential alternative to traditional fixed-income products for HNIs

In a well-balanced portfolio, allocation to debt is important for capital preservation and consistent income. It can act as a cushion against risks emanating from volatile equity markets and provides liquidity for short-term needs. However, high net-worth investors (HNIs) often end up with relatively low returns from traditional debt products due to their modest gross yield and being a part of the highest tax paying bracket in the country. In such a scenario, which fixed-income products should HNIs consider to earn a higher yield?

Traditional products

The traditional fixed-income products in debt allocation can include fixed deposits, government securities, commercial papers, etc., or indirect exposure to debt instruments via different types of debt funds. However, it is noticed that returns from such products are often limited on a post-tax basis (in the range of ~4% to 6%). If we account for the impact of retail inflation, returns from these products come down to -0.5% to 1.5% (assuming the FY25 average inflation of 4.5%), which is insufficient for wealth creation.

Non-convertible debentures

Due to lower returns from traditional debt products on a post-tax basis, investors seeking higher yield can look into direct investment in non-convertible debentures (NCDs)/corporate bonds. Direct subscription to single bonds is easier in public markets, whereby the issuer is higher rated (in the bracket of AA to AAA), information is publicly accessible, and the average default rate is low.

Investors can potentially earn higher yields if they invest in A and lower-rated bonds compared to the AAA and AA segments of issuers. However, investing in the A to BBB (or unrated) segment requires close monitoring and strict due diligence due to higher credit risk compared to the AA and AAA segments. Therefore, taking direct exposure to such corporate bonds could lead to elevated concentration risks and potential losses due to defaults.

As an alternative, one may look at Semi-liquid alternative investment funds (AIFs) in the private credit space.

Semi-liquid private credit AIFs

Over the past decade, private credit AIFs have evolved from a niche concept into a widely used investment vehicle for high-net-worth individuals, institutions, and family offices. What distinguishes them is their ability to generate risk-adjusted returns due to their low correlation to public markets and a diversified pool of assets. Their portfolio doesn’t need to be marked to market every day.

However, many investors seeking a high-yield investment vehicle hesitate to invest in a close-ended private credit AIFs due to longer lock-in requirements. This is where semi-liquid funds come into consideration.

Semi-liquid funds in a private credit space are structured as open-ended vehicles (as Category III AIF), suited to investors looking for flexibility to subscribe and redeem at regular intervals. Along with periodic liquidity, it enables investors to earn net returns that are estimated to be 100-350 basis points higher than post-tax returns from traditional debt products.

Secondly, it provides investors with access to a global practice that is estimated to have cumulative assets under management (AUM) of ~US$1 trillion globally. Investors keen on accessing the private credit market with an exit/liquidity option can also invest in these funds with a lower ticket size (below INR 1 crore) via the Securities and Exchange Board of India (SEBI)’s Accredited Investors framework.

Thirdly, being a private credit vehicle, semi-liquid funds take exposure to multiple entities across diversified sectors, thereby helping reduce concentration risks and potential losses from defaults. It can provide the option to receive regular income or allow compounding of income at the discretion of the investor.

To summarize, semi-liquid funds provide a favourable option for investors who are looking to invest in the private credit market but are reluctant to do so due to the lack of interim liquidity. It aims to bridge the gap between high-yield, illiquid, and low-yield, liquid investment options and broaden access to the private credit market by providing investors with an option to exit at their discretion.

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