Why alternative investment funds are betting on performing credit

AIFs are meant for ultra-high net worth and high net worth investors who have adequate surplus to park for longer tenure. (iStockphoto)
AIFs are meant for ultra-high net worth and high net worth investors who have adequate surplus to park for longer tenure. (iStockphoto)


Mutual funds have cut credit exposure after the Franklin Templeton crisis; banks and NBFCs have less flexibility.

Credit risk is no longer a popular term among mutual fund (MF) investors after the Franklin Templeton crisis that shook the MF industry in March 2020. From managing 61,837 crore of assets under management (AUM) before FT crisis, the credit risk MFs now manage 24,687 crore of AUM, which translates into a decline of about 60%.

On the other hand, banks and non-bank financial companies (NBFCs) are constrained in terms of the type of credit exposure they can take, due to regulations stipulated by the Reserve Bank of India.

This has given opportunity to alternative investment funds (AIFs) to steadily increase their activity in the private credit space. In 2022, deal value for AIFs in the private credit space stood at $2.3 billion ( 18,926 crore). According to industry experts, performing credit space is where sizeable amount of new AIF flows is getting deployed.

Consultancy firm EY in a report in November 2021, said the opportunities in the performing credit market was expected to range between $39 billion and $89 billion over the next five years.


Performing credit refers to lending to companies that are running their business on an ongoing basis, have a long track-record and are profitable at Ebitda-level (earnings before interest, taxes, depreciation and amortization). These funds don’t invest in entities where the businesses are no longer viable, or are in distress.

Aakash Desai, chief investment officer & head - private credit at 360 ONE Asset (formerly IIFL Asset Management), puts it, “For us having a really strong and verifiable track record is important, governance of the promoters is important, fairly stable financials is important, payment track record is important. If you look at all of these aspects, you will typically get solvent growing profitable businesses itself, who are by themselves fairly stable, but have a requirement that is fairly unique and can’t be met by conventional lenders. That is how we would define performing credit," Desai says.


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Performing credit, according to Dipen Ruparelia, head-products, Vivriti Asset Management Co., “are companies with established business model, operating companies, and where the requirement for debt is for business growth, capex (capital expenditure) or working capital".

Performing credit AIFs typically invest in mid-sized companies with revenues of over 100 crore. These funds target yields in the range of 12-18%, depending upon the quality of underlying portfolio exposure (whether A, BBB or unrated).

These instruments are not necessarily rated by rating agencies. AIFs that look at only rated instruments, start from AA- to all the way down to BBB; which is the last notch for investment grade. Some AIFs even look at unrated securities, where the funds can generate higher yields.

“The regulation itself doesn’t require that underlying instrument be rated. Investors can do unrated and unlisted structures. However, we invest in the rating spectrum ranging from single A to BBB space," says Ashish Chugani who heads Nippon Life India AIF Management

Sundaram Alternates looks at unrated space, where the yields can be higher. “If these securities were to be rated, they’d be a notch below investment grade. We want to work with these companies with aim of helping them reach size and operational efficiencies, where they can graduate to an investment-grade-level," says Karthik Athreya, director and head of strategy-alternative credit, Sundaram Alternates.

“These companies may not be on radar of rating agencies or institutional investors. There are healthy, growing and unlevered businesses that we look at," Athreya adds.


Athreya says Sundaram Alternates would avoid companies where debt-to-Ebitda (earnings before interest, taxes, depreciation and amortization) is more than 4-times, it won’t do any investments against shares and stick to secured debt. These secured debt instruments come with covers based on business cash, business assets, promoter collateral, etc. AIF looks for opportunities in sectors such as financial services, auto, engineering, manufacturing, given Sundaram group’s own expertise in these sectors and geographically focuses on South India, given group’s strong presence in that region. AIF is also building expertise in healthcare and IT sector.

Vivriti Asset Management prefers rated instruments between AA- to BBB-. Dipen Ruparelia, head of products, performing credit, Vivriti Asset Management, says, “We look for companies which are typically bank-funded and get them to access capital markets," Ruparelia says.

On risk-mitigating measures, Ruparelia says Vivriti is looking at companies that are Ebitda positive and wants diversified portfolios. “As investee universe are not startups, there are no business model risks."

Shekhar Daga, head private capital, ICICI Prudential Asset Management Co, says AIFs investing in debt instruments have ability to provide flexible structures in terms of interest and debt repayment terms.

“For example, instruments can have a part of interest paid regularly and balance yield can be paid on maturity as redemption premium. There is no need of monthly payments; payments can be made in any frequency as may be mutually agreed depending on cash flows of borrower. Borrower can use cashflows from operations, dividend, asset sale or capital raise to service debt," he says.

Take the case of dividend. If the promoter wants to service the loan through dividend, he would get the cash flows on quarterly, half-yearly or annual basis, depending upon the frequency at which the company declares the dividends. So, the payment terms would need to be aligned with the cash flows. Further, Daga points out that AIF debt instruments can have flexible end use in the form of asset purchase, share purchase (for acquisition) or support to group company by the issuer. “This flexible bespoke terms attract issuers to raise capital from AIF as compared to traditional sources of capital," he adds.


AIFs are meant for ultra-high net worth and high net worth investors who have adequate surplus to park for longer tenure. AIFs are close-ended and in performing credit space, tenure of funds can range between 3-5 years. AIFs require minimum investment of 1 crore.

Depending upon the strategy followed by the fund, investors can expect returns of anywhere between 10-14% on a pre-tax, post fees and expenses basis. These funds can offer higher yields than regular debt investment products, but also come with higher risks. Like with any credit risk strategy, there can be default risks. The security taken by the AIF, whether through hard collateral, promoter’s personal guarantee, etc. can help with recovery, but still credit risks cannot be wished away .

Performing credit AIFs are set up as category II AIFs, which has been accorded a pass-through status. That means, capital gains from these AIFs are taxed in the hands of the investors, in the same manner as if these investments were held directly by the investors. Performing credit AIFs typically make quarterly payouts to investors, which are essentially coupons received by investee companies.

These AIFs have a hurdle rate of 10-13%, depending on asset manager and underlying exposures. Hurdle rate is minimum return fund is required to deliver, before asset manager can charge performance fee.

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