If you are an investor in India of any size, you must have been called to participate in the private credit market. This market has grown very rapidly in the past few years. The reason is simple – Risk-adjusted-Returns.
This is also called peer-to-peer lending and it used to be exclusive for bankers or other big lenders like mutual funds, NBFC, etc. and was not available to individuals.
What is private credit?
Private credit is a loan to a business by any non-bank lender. Borrowers are typically mid-sized companies that need financing for operations, an acquisition, or to improve their balance sheet. In India, banks have some restrictions that they can’t lend to retail grocery shops, restaurants, etc. This opens a huge opportunity for the small lenders to lend to them.
Private lenders do not have the same restrictions and can evaluate deals independently of any regulatory body. This is called the ‘small’ or ‘middle market’ and the banks seem to be finding it difficult to lend to them. If you are an investor in debt products like fixed income securities, private credit could give you better returns for the additional risks that you are taking.
Higher yields
Low default rates
Short term durations
Not regulated much giving flexibility
Better diversification unlike mutual funds
Private credit investments are not actively traded on any secondary exchange, so therefore investors are not subjected to Mark to Market risk and the low duration ensures that there is not much of interest rate risk.
Risks of investing
While there are obvious benefits to investing in private credit, this asset class does come with its risks too!
If you have given a loan for 18 months, it is likely that it will take 18 months of holding. Partial liquidity is normally not available. Since this is not exactly a pool of loans, you will have to hold for the whole tenure.
Though it feels good that there is less supervision, it also means that there is more risk.
Some deals could be complicated – a little greed of the borrower and eagerness of the lender could lead to by-passing the process -thus again increasing the risk.
Invest in private debt?
Depends on the size of an individual’s investments in Debt – only a small percentage of that can be allocated to such funds.
What is the future of private credit? Expect the mutual fund industry to launch a ‘private credit fund’ in their portfolio of debt funds.
A private credit fund will be an investment that pools money from multiple investors and invests in private credit deals. These funds will be managed by professional investors who source, analyse, rank, grade, and manage all of the investments on behalf of the investors. Once such funds are launched, the common man will have a far better option of investing, with some professional help.