- 8/4/2023
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NewsTranscript
00:00 Thanks for tuning in back again to the alternative bet.
00:16 We started off this series with new asset management and talking about the various forms
00:21 of alternative investments present in the country.
00:24 And towards the end of the previous episode, we gave a small slice of private credit funds
00:29 or the concept of private credit.
00:31 Now we thought today's episode, let's just dwell deep into private credit.
00:35 What is private credit?
00:36 What are the nuances around that investment or that asset class?
00:39 And how can investors take advantage of what is promising to be a very large market in
00:45 its nascency?
00:47 And the two co-founders of new asset management, Puri Jain and Hemant Daga with me.
00:52 Gentlemen, good talking to you guys again.
00:54 And I love your office, by the way, very nice, very modern, very young, and which is which
00:58 is what I believe private credit as a space is to India as well.
01:02 Absolutely.
01:03 We love hosting you also, Neeraj.
01:04 Thank you so much.
01:05 So let's talk about private credit.
01:07 Now give us a sense of what is private credit.
01:11 So conceptually, Neeraj, if you look at any company's balance sheet, it typically has
01:16 two sources of capital equity and credit.
01:20 And equity companies can go through stock exchanges, they raise public equity that is
01:24 called, you know, stock markets, public equity.
01:27 When you replace public with private participants, you replace it with individuals giving money
01:33 to a company to raise equity that effectively becomes private equity.
01:37 So instead of public, the word private replaces it.
01:40 That's public equity.
01:41 That's private equity.
01:42 Now, as I said, every company has equity.
01:46 Every company has debt.
01:47 Similarly, in the business of credit, there are two sources.
01:51 There is public credit and there is private credit.
01:55 Public credit is when, you know, companies go and raise money from the public at large,
01:59 whether it's through NCDs or through fixed deposits.
02:02 Very standardized terms.
02:04 Everybody has access to the same collateral cover.
02:07 Absolutely standardized in that sense.
02:09 Right.
02:10 And that's why it's called public credit.
02:11 Similar to public equities in that sense.
02:14 Now when an individual or a fund manager goes and does a bilateral credit deal, he gives
02:20 credit to a company on a bilateral basis, which is far more customized, structured,
02:27 collateralized in a unique way.
02:30 That is what is called private credit.
02:33 So effectively, similar to private equity, there exists an asset class called private
02:37 credit where individuals such as you and me, where asset managers such as NIO give credit
02:44 to companies on a bilateral basis.
02:46 These are far more structured deals.
02:49 Many given to mid and small size companies.
02:52 It acts as a source of capital for them.
02:55 And it can spur growth of these companies where typically they might not be able to
02:59 access banking channels in some situations.
03:01 You know, for example, if a company wants to do an acquisition finance, for example,
03:05 if a company wants to grow but doesn't want to dilute its equity, it would require debt.
03:11 And in those situations for growth financing, it might require private credit.
03:15 And that is the domain of private credit.
03:18 So effectively, in a nutshell, it's a bilateral deal, a deal done between two or three counterparties
03:25 with the company.
03:26 You're giving credit to the company.
03:28 And as an investor, we earn returns.
03:31 We derive comfort from the cash flows of the company, from the profitability of the company,
03:36 and also from the collateral cover, which acts as a second line of defense, like last
03:41 time you were explaining.
03:42 So there is cash flow from which you get paid your interest.
03:45 And there is collateral from which as an investor, you derive comfort.
03:50 It kind of safeguards the amounts that have been given to the company.
03:53 Absolutely.
03:54 So the first line of defense is cash flows.
03:56 As I said, all investing is about cash flows, right?
03:59 At the end, it's only about cash flows.
04:01 So cash flows is your first line of defense.
04:04 Collateral is your second line of defense.
04:06 And the good thing is these deals are bilaterally structured.
04:09 So there will be terms and conditions that the borrower cannot exceed a certain amount
04:13 of borrowing, his governance will be in place, the collateral will be ring fenced, there
04:18 will be control upon the bank account, all money coming in the bank account will have
04:22 an escrow control.
04:24 So it's a very guided way of approaching credit rather than a more public credit, which is
04:30 very pari passu, everybody equal, you don't have these controls.
04:34 So private credit is a far more bilateral structured credit approach.
04:39 And the need stems from borrowers because sometimes they cannot access banking channels
04:43 for certain users.
04:44 As I said, if a company wants to grow, but it does not want to raise equity, it can raise
04:50 pseudo equity in the form of credit, right?
04:53 If two brothers are in a family and one brother wants to settle his other brother, which happens
04:58 in real life, if he requires money for this, he will access private credit for that.
05:03 He cannot get banking money for that.
05:04 So multiple use cases.
05:06 Multiple use cases.
05:08 So that's in a nutshell.
05:10 Now we've kind of understood basic.
05:11 Now let's peel this off layer by layer and try and understand this.
05:16 So either of you and Puneet, maybe you can come on this as well.
05:19 Let's first talk about this market because not too many people know about private credit
05:23 and the investability.
05:24 So how is the market worldwide?
05:26 And how is it in India?
05:28 Because I believe that you guys have done this in your previous avatar as well.
05:31 So tell us a bit about the evolution of this industry, either of you.
05:36 So I think this market has existed forever.
05:40 So because private credit is ultimately giving money being given by a private individual
05:46 on a bilateral basis to a particular need.
05:50 So I think this has existed forever.
05:52 But if you look at the modern era, let's just look at US.
05:57 In US, this has become a very, very big industry from 80s onwards, where companies like Oaktree
06:03 of the world, KKR, Apollo, etc.
06:06 Each one of them have become more than $100 billion of size.
06:09 In fact, between these three, the size will be more than $500 billion of size.
06:15 Similarly, in case of India also, this industry has grown very fast over a four to five year
06:22 period.
06:23 At this point of time, the total amount of money being invested on an annual basis is
06:27 more than 10,000 crores.
06:29 And what was it at the start?
06:30 This was five years back.
06:31 So let's say around 2017-18.
06:32 Yes, I would say most of the industry started post 2016.
06:37 Which means that over a six, seven year period, this industry has become more than 50,000
06:43 crores in terms of size.
06:45 At this point of time, it is attracting investments more than 10,000 crores every year.
06:50 It is growing at a pace of more than 12%.
06:54 The growth definitely is significantly faster than either banking credit or public equities.
07:00 I would say that among the various sub-segments in the financial industry, this segment is
07:06 growing amongst the fastest at this point of time.
07:08 So when you say that this has always existed, you're talking about how in the layman culture,
07:12 "Mujhe danda betaani hai toh aapne mujhe paisa diya" so that always existed.
07:15 But in the form of a fund investing into a company that has started largely post 2016.
07:21 Yes.
07:22 Yes.
07:23 And growing at 12% per annum.
07:25 Is that the kind of growth that happened back in the other countries as well when it started?
07:29 I'm just trying to understand if India is growing at a faster pace than what happened
07:33 to other countries in its nascency.
07:34 Any thoughts there?
07:35 Actually, there's an interesting one, Neeraj.
07:37 If you look at global markets, private credit saw a major boost post 2008.
07:44 Okay.
07:45 Globally, what is happening, and this is a very important point, globally, banks are
07:49 becoming tightly regulated organizations, right?
07:52 And that's why a large part of lending is moving to asset managers.
07:57 Because asset managers don't run any asset liability mismatch.
08:01 And when you're doing structured lending, you don't want asset liability mismatch.
08:05 I think that's been our biggest learning in the last three years, right?
08:08 So which is why asset managers are the best suited vehicles.
08:11 This industry globally has grown 15% per annum, India is witnessing similar rates.
08:16 Today, globally, this is more than a trillion dollar of alternative assets.
08:23 Global alternative assets globally is $15 trillion.
08:26 Private credit is the fastest growing alternative asset class.
08:31 And you'll be surprised, I think a lot of this comes from its returns profiles also.
08:35 Returns have been extremely resilient.
08:37 Yeah, and I was gonna come to that.
08:38 But I just thought we'll first tackle the structure.
08:40 So you're saying that globally, it is growing at a rate of 15%.
08:44 And in India too, right now, it is about 12%.
08:46 And growing at a fast clip, and it'll accelerate as time goes.
08:49 Okay.
08:50 So, guys, what is the structure like?
08:51 Is it an AIF structure?
08:53 How do I as an investor, let's say if NIO is having a private credit fund, if I'm not
08:57 wrong, so how do I as an investor, give money to NIO?
09:01 And how does the NIO put the money to work?
09:03 Can you talk a bit about that?
09:04 Either of you again.
09:05 I'll take a shot at that.
09:10 So yes, investors can, you know, participate in this big opportunity through alternative
09:16 investment funds.
09:17 Okay, this is an AIF structure.
09:19 This is an AIF structure.
09:20 And these are category two AIFs, basically meaning a tax pass through status.
09:26 Typically, the way these funds work is an investor says that I would commit 1 crore
09:32 to this fund, right?
09:33 Which is the bare minimum, which is the bare minimum.
09:35 So he puts 1 crore to work and he says, this is my commitment.
09:39 But in a debt instrument, typically, asset managers don't take all the money upfront.
09:44 You know, because in a private credit AIF, as an asset manager, we will do 15 to 20 investments.
09:51 Doing 15 to 20 investments will typically take two years time because every single investment
09:57 takes two months, three months, right?
09:59 So typically, we would take money in installments.
10:02 Why would I take your money and just put it in a liquid fund at 6%?
10:05 Right?
10:06 That was not the purpose for which you gave me the money.
10:08 So we take money in installments.
10:09 These are typically called drawdowns in a more technical term.
10:13 So we take money in installments.
10:14 If somebody commits 1 crore, then today he might need to pay 20%.
10:18 Then after three months, he might need to pay 20% and so on and so forth.
10:22 So typically, over 15 to 18 months, the entire 1 crore is put to work.
10:27 So the entire money is not going one shot as such in these funds.
10:31 And investors can participate through alternative investment funds.
10:35 The good thing is, I think SEBI has truly, you know, direct classes have also come in
10:41 AIFs.
10:42 So investors can take benefits of direct classes also in these AIFs and can enjoy lower costs
10:47 in transacting in these funds.
10:49 Okay.
10:50 Okay.
10:51 Oh, can you just explain that point once more?
10:53 Absolutely, Raj.
10:54 So the way the mutual fund industry evolved, there are regular classes and there are direct
10:58 classes, right?
10:59 Direct classes typically have slightly lower management fees.
11:03 Similarly, in the alternative investment industry, I think what SEBI has done is amazing.
11:08 I think this will spur the industry even further.
11:11 There are regular classes and there are direct classes.
11:13 So for savvy investors, they can just directly access it without the middleman or the advisor
11:19 being there to tell them where to go.
11:21 Yes.
11:22 And for people who are just learning the rope, it's always best to use an advisor because
11:25 the advisor can tell him which fund is better.
11:27 They can come maybe through the regular channels, but for larger clients who've done this themselves,
11:32 they can take benefits of lower fees.
11:34 Okay, great.
11:35 Okay.
11:36 Just before I come to Puneet about what's the kind of fun, what is the kind of investments
11:39 that happen, just one quick follow up.
11:41 What are the kind of fees that an investor has to pay through both the regular and the
11:46 direct channels?
11:47 So fees on these funds typically vary, Neeraj, but ballpark, most of these funds have a fixed
11:55 fee and a performance fee.
11:58 Okay.
11:59 Okay.
12:00 Fixed fees would typically be in the range of one to one and a half percent.
12:04 And then there is a performance fee, which is typically 10% or 15% performance fee.
12:09 Of a certain threshold of say 10 to 12% pre-tax.
12:12 It's pretty similar to what an equity PMS anyways has been doing.
12:16 Absolutely.
12:17 It's very similar.
12:18 It's very, very similar to an equity PMS because returns are also relatively similar.
12:22 The good thing is, and at NIO, this is one of our philosophies to keep the fees probably
12:29 the lowest because in debt, and this is very important for investors to understand, I think
12:34 post fees returns in debt investing matters significantly.
12:38 Sure.
12:39 Yeah.
12:40 Makes sense.
12:41 Okay.
12:42 So that's a few layers peeled, a few more left.
12:47 So Puneet, I would love to understand, one, what are the kinds of returns that an average
12:52 fund can give?
12:53 Because Hemant spoke about how the post fund returns or post fee returns are important.
12:57 And how does a CIO generate those kinds of returns?
13:03 I think it's both easy and difficult.
13:06 It may look easy because I would say easy because the asset class per se has a lot of
13:12 advantages because unless the asset class has certain advantages, there's a right to
13:19 win in this asset class.
13:21 And funds in US, funds in Asia, funds in India have delivered returns in excess of 20 odd
13:27 percent.
13:28 So this means that asset class is strong and has capability to deliver returns in excess
13:33 of 20% on a consistent basis.
13:37 The difficult part is execution.
13:39 The difficult part is making sure, finding the right opportunities, working with those
13:45 set of management and having the right structure so that it creates a win-win opportunity for
13:51 both investor as well as the borrower.
13:55 Sure.
13:56 Got it.
13:57 And I will typically split these deals into three categories.
14:00 So first and very important category is sponsor financing.
14:04 Wherein we will give money to a sponsor and sponsor may have a requirement of increasing
14:11 equity stake into an existing company or maybe acquiring some other business.
14:15 By sponsor you mean the person which is taking the money or the company which is taking the
14:20 money.
14:21 So by sponsor which means that one is there is an operating company and one is the promoter
14:27 of the operating company.
14:29 By sponsor I mean the promoter of the operating company.
14:33 So this is at the sponsor level.
14:35 So typically in case of credit, money can be taken either at the operating company level
14:40 or money can also be taken at the promoter level.
14:43 At the promoter level, it is called sponsor financing.
14:46 Okay.
14:47 Just a follow up.
14:48 Why would a fund be comfortable giving the money to a sponsor because the sponsor will
14:51 not have the operating cash flows that a company would have?
14:54 Yes.
14:55 So this is a very, very important question.
14:58 In many cases, what happens is that sponsors sometimes get ability to purchase stakes at
15:05 some discount to market prices.
15:08 So the best example could be that the sponsor may be able to buy equity stake from a private
15:14 equity investor who may have originally invested.
15:18 So, in that case, he is getting an opportunity to consolidate his stake, to improve his stake
15:24 and to improve his position within the company itself.
15:29 So the repayment may be from two sources.
15:33 One is that sponsor itself may have some small businesses which can repay.
15:39 Otherwise, the repayment can be from dividend or repayment can be from sale of stake at
15:44 a later stage, maybe through an IPO or maybe to other investors at a later stage.
15:51 And this is a pretty large market.
15:52 Got it.
15:53 So, these are the two kind of ring fence via agreements with the sponsor about how the
15:57 repayment is going to take place.
15:58 Yes.
15:59 Okay, great.
16:00 The good thing in private credit is I think the path to exit is relatively well defined.
16:07 And there are covenants which try to move in this direction.
16:11 Got it.
16:12 So as an investor, you're in control.
16:14 As an asset manager, we are in control of our destiny.
16:18 And that is the comfort that this asset class gives.
16:21 So there is cash flow, but there is a path to exit.
16:24 And unlike public credit, I mean, it's a very general path to exit, right?
16:30 But here there is a very directed path to exit.
16:33 Very predictable.
16:34 I would say very directed path.
16:35 Very directed path.
16:36 Yeah.
16:37 And the returns in that sense.
16:38 Okay.
16:39 So just before we come to, okay, let's first get the three parts out.
16:42 Then I would want to talk about the kind of defaults that might happen as well and so
16:46 on so forth.
16:47 But you mentioned sponsor financing as first.
16:49 What is the second one?
16:50 So the second part will be working capital financing or growth financing.
16:55 So here there are many cases where the plant is built, the capex has been done, but there
17:01 is not educate financing to take the plant to the optimal level.
17:06 Okay.
17:07 Let's say the plant is running out of money.
17:08 The plant is running out of money.
17:09 Absolutely.
17:10 So the plant may be running at 60% capacity utilization.
17:13 The entire machinery is there.
17:14 You just need to pump in certain amount of money and the capacity utilization can go
17:19 from 60 to let's say maybe 90%.
17:21 In this case, the borrower is able to earn returns, maybe in excess of 50% on our capital
17:27 and will have no challenges paying our return of 20 odd percent given the extent of benefit
17:33 involved by taking that money.
17:35 Okay.
17:36 20 odd percent.
17:37 I've not gotten to the returns part, but thank you.
17:39 This is a very interesting one, Neeraj.
17:41 And working capital finance, growth finance, last mile financing, these are all words that
17:48 are used interchangeably.
17:50 But effectively what you're trying to do is you're trying to put 10 rupees or 20 rupees
17:54 to work and you're sweating an asset which is worth 100 rupees.
18:00 So by putting that last mile connectivity of capital, the 10 to 20 rupees is actually
18:05 sweating on an asset base of 100.
18:08 So technically now on 100, if you make even 15, on our 10, 20, the returns get hugely
18:16 high.
18:17 And which is what I think Puneet was saying, it's actually a win-win.
18:20 This capital is highly productive.
18:23 It's capital which is productive for the investors.
18:25 It is capital which is very productive for the borrower also.
18:28 Why is it that, is it because of the nature of the norms that promoters are not able to
18:35 access this money from the banks or financial institutions?
18:37 Because there are a bunch of financial institutions out there as well.
18:40 So how does private credit come in the first place?
18:44 So there are several situations, like for example, as a promoter, you set up a plant,
18:52 right?
18:53 Now, initially banks will fund you for the cost of the project.
18:56 But if there is a cost overrun, banks typically will not fund you for cost overruns.
19:00 There can be cost overruns in real life, right?
19:04 Usually there are.
19:05 Now there can be situations where there is a project which is, let's take a real estate
19:09 building, right?
19:11 Building is almost ready, seven floors out of 10 floors.
19:14 It requires capital for three floors.
19:16 Typically last mile financing in real estate from banks is typically not available.
19:21 So that's also a situation, right?
19:23 Working capital has got stretched.
19:24 So suddenly raw material prices have gone up.
19:26 Working capital has got stretched.
19:28 Banks are comfortable only up to a certain level.
19:30 In those situations, we feel, no, this capital is actually making a lot of sense.
19:35 Because banks will follow a relatively cookie cutter approach sometimes, right?
19:39 But as an asset manager, you can take a view that this capital will actually sweat the
19:43 asset even more.
19:44 So that's why all these opportunities come about.
19:48 Got it.
19:49 Got it.
19:50 Thanks for that explanation.
19:51 Okay.
19:52 So, Punit, that's part two.
19:53 Now, part three, sponsor financing, working capital financing.
19:56 What's the third one?
19:57 Part three is refinancing.
19:58 And I think the best example to explain this will be the hotel industry.
20:06 If you look at the hotel industry, typically they get financing for a seven to 10 year
20:12 duration.
20:13 But a hotel asset is continuous for 30, 40 years or perhaps.
20:18 Now what happened was, let's say hotels which are set up maybe 10 years back, they would
20:24 have repaid the money.
20:25 But because of COVID, they lost three years.
20:29 So at this point of time, the hotel industry is doing very, very well.
20:34 They are having the best of cash flows, but they are not able to make full 100% principal
20:40 repayment.
20:41 So what they just require is elongation of the liability period.
20:47 So principal repayment, which were due possibly this year and next year, will be rescheduled
20:53 to pay over a four to five year period.
20:55 These companies are making large, very healthy cash flows.
20:59 There is security cover, which is more than 2.5 to three times risk possibly is a lot
21:05 lower given the fact that hotel is running while initially when the money was given,
21:11 the hotels were at a land stage.
21:14 So these kinds of opportunities cannot be accessed by banks because banks typically
21:19 do not do refinancing.
21:21 So in these kinds of refinancing, and this is a more juicy segment of private credit,
21:27 but for leadership managers like us, you have the sole play.
21:31 Got it.
21:32 Okay.
21:33 And you guys are saying that banks which have lent 10 years ago, currently when it comes
21:38 up for renewal, because the bank manager also or the bank finance executive also see that
21:43 the hotel industry is in a good shape, they cannot extend the ten year period.
21:47 They cannot refinance or restructure that long.
21:52 Because then there is moral hazard involved, right?
21:54 Because technically as a regulator, you will not be able to judge whether it was done for
21:59 right or wrong reasons.
22:00 Got it.
22:01 If only when an external party does it, then that wedding happens.
22:05 Okay.
22:06 Now Hemant Puneet mentioned something in the second answer, which is the kind of returns
22:10 when it came to the working capital piece, which is, I think I heard the number of 20
22:13 odd percent.
22:14 Now that's remarkable for a product with so much of predictability as well.
22:20 Tell us a bit about the kind of returns that private credit is making in India, a proof
22:24 of concept in India, and how does this differ from what could be happening in the rest of
22:29 the world?
22:30 So I'll start from the rest of the world.
22:32 There's a longer history and these are far developed markets, right?
22:38 In the US markets, Neeraj, in the last 10 years, the top 25th percentile funds have
22:47 delivered 13% compounded dollar returns.
22:52 13%.
22:54 The US equity markets have delivered 8% compounded in this period.
22:59 Now typically in US, if something delivers 13% and you assume a dollar rupee depreciation
23:04 of 4% every year, that should very, very intuitively translate to 17 to 18% rupee returns.
23:12 So we are not talking anything out of the whack in that sense.
23:15 If in the US there is 13% dollar, just Apple to Apple, that should be 17 to 18% rupee in
23:21 India.
23:22 And the very fact that India is a market which is nascent, growing phenomenally, I think
23:28 returns can obviously be slightly better than 17 to 18 because US is a far developed market,
23:33 which is why in India, most of the asset managers and even Puneet and me in our previous avatars,
23:39 we've delivered slightly northwards of 20% gross IRRs.
23:43 And that's true for many asset managers in the country, large asset managers who have
23:46 raised more than $1.5 billion from sovereign wealth funds.
23:51 Compounded over how many years?
23:53 Compounded typically over three to four years.
23:54 These are relatively shorter durations in that sense, but compounded over this period
23:59 of time.
24:00 20% dagger for three or four years.
24:02 Absolutely.
24:03 Wow.
24:04 And once again, the point I'm trying to make is, it's not out of the whack.
24:08 In the US, if 13% dollar can be delivered, which is higher than US equity markets, and
24:14 you are just for the dollar rupee, 17 to 18% rupee is a very natural expectation.
24:24 And just in the last 10 years, just look at the macro context.
24:30 In the last 10 years, inflation in India was far higher than US.
24:34 Interest rates in the US were far lower, despite that $13 got delivered.
24:41 So you have to put that in context.
24:43 And just if I could just complete this, Puneet made an interesting point on working capital
24:47 finance.
24:48 I'll give a very intuitive example.
24:52 This might not be the exact way it plays out in the real world.
24:56 Assume I am a promoter, I put up a 100 rupees plant.
25:01 Any plant, a 10% return on capital, will you be happy with that?
25:06 That's very normal expectation.
25:07 So on 100 rupees, I will be able to make 10 rupees.
25:09 Now assume I've run out of working capital for some reason or the other.
25:14 And we as asset managers come and give you that 10 rupees working capital to start the
25:17 plant.
25:18 Now when we give you 10 rupees, that 10 rupees will produce 10 now, otherwise it was producing
25:23 zero.
25:24 Now technically, as a promoter, you're making 100% returns on my money.
25:28 Now in this situation, for a short period of time, if we want, we say give us 2 rupees,
25:34 out of the 10 that you're making in absolute terms, and think in absolute terms, Neeraj,
25:38 out of the 10, give us 2.
25:40 Will you do it?
25:42 Any normal person will do it, right?
25:44 So in percentage terms, it sometimes sounds high, but in real life, what happens is, in
25:48 a company's life of 30 years, 2 years or 3 years is more about absolute maths.
25:55 It's not necessarily about percentages.
25:58 You're almost making it sound that, not in a negative way, but a private credit fund
26:04 looks at an opportune time to give credit to a firm in need, in order to execute the
26:14 last mile, which enables the company to earn the returns that it is supposed to earn, which
26:21 it wouldn't have been able to do without the availability of the credit.
26:24 And therefore, the company or the promoter, she or he is ready to pay you a slightly larger
26:31 than what it normally appears to be return, because that's the oxygen that was needed
26:35 to finish the task, so to say.
26:37 I think absolutely yes, I wouldn't use the word oxygen.
26:43 Oxygen means, you know, desperateness.
26:45 Here that money is making the acid sweat better.
26:49 The acid is already there.
26:50 It's a performing plant.
26:52 By providing that extra 10 rupees, the acid is sweating better.
26:56 So I wouldn't use the word oxygen.
26:57 This is not a case of, you know, desperateness.
26:59 It is logicalness to this 20% getting on.
27:02 I'll personally just add also, like it is well accepted that private equity can deliver
27:07 returns, which is maybe say 560 basis points higher than public equity.
27:14 Similarly, the same concept applies for private credit as well, where a private debt can deliver
27:20 returns which is maybe 600-700 basis points higher than public debt.
27:26 A typical public debt is available in a zone of maybe 10-14%.
27:31 So if you just add up maybe 6-8%, you are at a range of between 80-22% for let's say
27:38 private debt.
27:39 Absolutely.
27:40 Here's the thing, right?
27:41 Okay, first, let me get the risk factor out of the way, because the question that I will
27:45 obviously ask you is that if you can, let's assume a fund is four years, but at the end
27:49 of the first fund or whatever, let's assume you have one fund.
27:53 And at the end of the first fund, I'm sure you think about the second fund, right?
27:56 So, in effect, if you are a continuous journey, a continuous loop of funds, which deliver
28:01 nearly 15-20% year after year, over a period of 10 years, then you are effectively giving
28:07 returns which are more predictable.
28:11 I'm using that term, although you didn't.
28:13 More predictable than equity returns at a far lower risk than what is there in equity
28:17 markets.
28:20 That is the compelling case for private credit.
28:23 Interesting.
28:24 What are the risks to this then, Hemant?
28:25 That's the key point.
28:26 Sorry, I don't know if you're making a point, but after that, I would love to understand
28:28 what are the risks to this, because this sounds very positive.
28:31 So firstly, I wouldn't compare this with equities.
28:34 I think, last time when we discussed, I think all asset classes have a place in the sunrise,
28:41 whether they are equities, whether they are debt instruments.
28:44 It depends on your asset allocation at the end of the day.
28:47 What are the risks in this?
28:49 I think risks are more obviously in any investing, I think taking a call on how that industry
28:58 and how that company will perform in the near term is very important, right?
29:02 Because we are finally all earning out of the cash flows of the business.
29:07 So if there are severe downturns, there is a severe dramatic change to the business model,
29:12 then will our returns get impacted?
29:14 Obviously, they will get impacted, right?
29:16 It is like saying when you invest in a stock and there is a sharp downturn, your returns
29:19 will get impacted.
29:21 The good thing is private credit is resilient as an asset class.
29:25 I mean, even when we look at Indian markets and the kind of private credit returns that
29:29 have got delivered, despite COVID, people have delivered 20% returns.
29:33 So there is resilience, but at an individual company level, can it get severely impacted
29:37 because of a sharp economic downturn in its sector?
29:40 The answer is clearly a yes.
29:42 Puneet, would you love to add a few more?
29:45 Sure.
29:46 So, another important risk in terms of investing is that in many cases, promoters do not want
29:52 to dilute and they think that private debt can be a solution of not raising equity.
29:58 But that immediately emerges as a risk because equity has to be paid over a longer term period,
30:05 but private debt as an asset class has to be repaid over a three to four year period.
30:09 So therefore, they can be an asset IP mismatch.
30:12 So wherever private debt is as a substitute for equity, one has to be very, very careful
30:17 in terms of investing.
30:20 So another important part is in terms of flexibility of payments.
30:30 So if you are investing with a certain horizon, and if the company starts to do well, you
30:36 should be willing to take payments faster as well.
30:39 So to make sure that you align your cash flows completely in terms of performance of the
30:45 companies, you should not provide excess capital than what the corporate requires, because
30:52 ultimately you are generating returns which are slightly above normal.
30:56 So you should also make sure that even the incremental capital which a corporate is generating
31:01 also meets the benchmark of the money which you are lending.
31:06 But yes, so you have to tick mark various boxes.
31:09 And once you tick mark various boxes, you follow the investment very carefully.
31:13 The chances of losing capital are actually very minimal, at least in my experience, and
31:19 maybe Hemant can also speak.
31:21 In my experience, of all investments I have done, I haven't lost capital.
31:28 So, therefore, yes, if you tick mark various boxes, you may end up losing some return,
31:36 but risk of losing capital are actually very, very low.
31:40 And I'll give an intuitive explanation of that, you know, what Puneet said, where the
31:44 risk of capital loss is minimal.
31:47 So Neeraj, typically all investments are backed by cash flows.
31:51 And the first starting position, and I want to reemphasize to all the viewers, it is about
31:56 cash flows.
31:57 Collateral is only a second line of defense.
32:00 Now let's assume the cash flows for some reason or the other don't pan out.
32:04 That can happen in real life.
32:05 Now we have collateral, right?
32:08 Typically, most lending is done at least at two and a half to three times collateral cover.
32:14 So effectively what you're saying against 100 rupees, you've got 250 rupees of collateral.
32:19 Now very interesting statistic, I think post, in the last several years in India, whenever
32:26 resolutions have happened of slightly stressed assets, resolutions have also been typically
32:31 yielding 40 cents to a dollar.
32:34 What does that mean?
32:35 Against your 100 rupees, you've realized 40 rupees.
32:37 Now, how much collateral did we have Neeraj in this case?
32:40 250.
32:41 Now on 250, if we have to realize 40 cents, that means your 100 rupees will come back.
32:47 And which is why it's very intuitive that at least if you've chosen an asset well with
32:52 decent diligence, right, and you are decisive, then on 250 to recover 100 is not an unreasonable
32:59 task.
33:00 What's been the default rate for your funds, whether in the previous avatar or at NIO,
33:04 I believe you guys have a fund as well.
33:05 Maybe we just started maybe.
33:07 So the number of years is not four years, but lower.
33:11 But what is the typical default rate here?
33:14 So once again, Neeraj, I think there are two terms that I would want the viewers to get
33:20 used to.
33:22 I think default, and there is a word called loss given default.
33:29 A company can default, and yet there can be some recoveries out of it, right?
33:33 Because all assets don't collapse.
33:36 So can there be delay in interest payments in some of these lendings?
33:40 The answer is a clear yes.
33:42 During COVID times, did we witness delays in interest payments?
33:46 So is that a default?
33:47 The answer is a clear yes.
33:49 But as long as fundamental value in the asset is there, see we were we lend to an asset
33:54 which was generating cash flows.
33:56 It's like saying a stock doesn't do well for two quarters, but does the company go out
34:00 of fashion?
34:01 Absolutely no, right?
34:02 At that time, we typically tell viewers, you should add if the company is fundamentally
34:06 fine.
34:07 So default and loss given defaults are very important words.
34:12 Can there be delays?
34:13 Can there be defaults?
34:14 The answer is yes.
34:15 Out of 100 companies, can that happen to seven, eight companies?
34:18 The answer is a yes.
34:20 Now, can there be delays in seven to eight out of 100?
34:24 Yes.
34:25 But losses, I would say maybe one or two out of 100.
34:28 Are you saying that out of the total money, let's assume you had 100 crore fund, and that
34:32 100 crores invested in the past in your previous avatar as well, the losses have been maximum
34:38 with a tune of two crores?
34:40 One to two crores.
34:41 Okay.
34:42 And that's not a certainty, of course.
34:46 It's not a certainty, but this has been stress tested.
34:49 Is that an industry wide trend as well?
34:50 Just trying to understand.
34:51 In most funds, I would say that.
34:54 Obviously, it depends upon diligence levels, the teams, and that's where specialization
34:58 comes to fore.
35:00 That's where investors should carefully evaluate teams, right?
35:03 Teams that have delivered across economic cycles.
35:07 But typically, that's an industry wide phenomenon.
35:09 Okay.
35:10 Okay.
35:11 Great.
35:12 So, we've got a decent understanding of what this product is about.
35:16 Is there something that we've missed that you would like to add before we wrap up this
35:18 episode?
35:19 I believe we covered risk and the nature of the thing.
35:22 Is there something that we missed?
35:23 There's something that I would want to cover is, I think the cash flows to an investor.
35:31 This is a regular income product, right?
35:34 Okay.
35:35 And typically, when Puneet was saying that, you know, 18 to 20% gross returns can be generated.
35:41 Out of 18 to 20, the good part, Neeraj, is 10 to 13% or 10 to 14% will come as regular
35:47 cash flows.
35:50 And typically, once you take a time, as an asset manager, we will take one year to invest,
35:54 right?
35:55 But after that, every year, regular cash flows go back to customers.
36:00 And cash flows can be interest payments, plus some principal returns.
36:04 So on your 100 rupees, typically, 25% can be regular cash flows, interest plus principal
36:10 repayments.
36:11 And that is the beauty of this asset class.
36:14 It gives you very regular cash flows.
36:16 And finally, if cash flows are coming, that means your returns are safe.
36:19 That means your returns are getting crystallized.
36:21 Yeah, most certainly.
36:23 Okay.
36:24 So, well, if I can summarize it in some fashion, you're not taking the entire one CR or whatever
36:30 the minimum number is, or whatever the number is at one go.
36:34 But the cash flows start coming in periodically through the life cycle of the fund, be it
36:40 four years, five years as the case may be.
36:43 And you guys are saying that globally, it is generating about 13% return.
36:48 You have experienced 15 to 20% return, 20% if I'm not wrong, Kagar, for a life cycle
36:52 of the fund, which is about four to five years.
36:54 Absolutely.
36:55 Great.
36:56 Jamin, this was lovely.
36:58 A lot of knowledge shared about private credit, and it's an interesting asset class.
37:02 May it prosper.
37:03 And thank you for sharing the details with us.
37:06 Thanks a lot.
37:07 Pleasure always interacting with you.
37:08 Thank you.
37:09 Thank you so much.
37:10 And thank you for tuning into yet another very interesting and a new concept introducing
37:16 episode of the AlternativeBank.
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