According to data from the Securities and Exchange Board of India, funds raised by Category II AIFs – investment funds that can invest only in unlisted companies – from investors increased from ₹1.24 lakh crore in March 2020 to ₹2.40 lakh crore in June 2022. AIFs cannot accept less than ₹1 crore from every investor.
Affluent investors are preferring these over debt mutual fund schemes betting on lower-rated papers because of higher returns and tailor-made structures.
“AIF structure scores over a mutual fund as it is customisable to cover risks of illiquidity or lack of daily price availability of underlying investments,” said Ravi Vukkadala, chief executive officer at Northern Arc Investments.
Mutual funds have been hesitant to invest in lower-rated paper over the last couple of years after a series of defaults by issuers, resulting in an erosion of returns. This led to mutual funds drawing flak from investors. As per data from Morningstar Research, a mere 0.3% of the debt industry AUM is in ‘A’ and below rated paper, with as high as 96% of the assets being in AAA-rated paper only.
“Post the liquidity crisis of 2020, asset managers have focused largely on high-quality paper,” says Kaustubh Belapurkar, director-research at Morningstar India.
These debt AIFs must offer higher returns than mutual funds because of the less favourable tax benefits of indexation that mutual funds enjoy.
“Investors need to earn at least 200-300 basis points higher post-tax returns to compensate for the extra risk as compared to a debt mutual fund,” said Munish Randev, founder of Cervin Family Office. While debt mutual funds could give a return of 7-7.5% before expense and tax, financial planners believe investors should earn at least 14-16% in a debt AIF to account for the expense, higher taxation and risk involved.
“We eye companies that are backed by private equity, new age technology business and companies that are disruptors,” said Saurabh Jhalaria, CIO for alternative credit strategies at InCred Asset Management. Jhalaria believes there are good opportunities in fintechs that lend to small ticket consumers and in the electric vehicle space.
Some AIFs are lending to new-age technology companies and disruptors in the private credit space that could need money for a time frame ranging between one and three years.
Many of the companies that AIFs lend to are those that banks and mutual funds are unwilling to touch with a bargepole.
“Unmet structured credit demand of small and mid-sized corporates provides an attractive opportunity for a credit fund focused on their needs,” said Vikaas Sachdeva, managing director of Sundaram Alternates. His fund targets mid-sized companies across a diversified spectrum with an average internal rate of return (IRR) of 16-17%.
Given that high returns carry higher risk, it is important investors go with asset managers that have been through multiple cycles. “We look at parameters like governance, cash flows, board structure, promoters’ track record, auditors, etc. before we lend to a company,” said Vukkadala.