The size of India’s bond market stands at a little over $2 trillion, but nearly three-fourths of this market is dominated by federal and state government debt securities. While the corporate debt market stands close to $500 billion, this market is disproportionately dominated by highly rated issuers. There are around 22,000 enterprises with an investment grade rating, however issuers rated AA and higher have cornered over 80 per cent of debt issuances on an average over the last decade. The IFC and SME finance forum estimated a funding gap of $230 billion for micro and small enterprises (based on data up to 2018).

Since 2010, impact investors have collectively committed $10.8 billion to for-profit impact enterprises that have touched the lives of some 490 million people. During that period, annual impact enterprise investments have grown from $323 million in 2010 to $2.7 billion in 2019. However, impact investors have heavily favoured equity investments (72 per cent or $8.4 billion) over debt (28 per cent or $3.1 billion) for growth and working capital needs.

Therefore, it is clear that the lack of access to debt for emerging enterprises is universal across sectors, and substantially unmet by commercial/impact investors alike.

Credit markets in India include both formal bond markets as well as bilaterally negotiated debt. The market for small and medium firms is illiquid and is inadequately addressed by the formal financial sector. As a result of this, markets remain inefficient beyond the larger enterprises. Spreads of corporate debt yields (beyond the AAA and AA rated category) over government debt are very steep, indicating that the lack of liquidity plays a greater role in cost of debt rather than risk premium.

Accessing credit markets

There are multitude of factors that make accessing debt markets difficult for both non AAA issuers and investors.

Impediments toborrowers : limited market access — the bond markets are dominated by AA and above rated bonds; limited investor reach — borrowers tend to reach to a limited set of investors impacting price discovery; long process timelines and cost — traditional relationship and human-intensive-led processes, high transaction cost; and requirements for collateral — bank lenders have traditionally required significant collateral against debt, which impacts the quantum of debt available

Impediments to lenders : concerns of corporate governance — emanating from the perception of business practices, quality of financial audit and lack of access; lack of discoverability — higher proportion of private placement leads to limited access to investment opportunities; limited information availability — lack of information repositories that could provide consistent and reliable information on privately held issuers; and weak liquidity in secondary markets — investors are forced to adopt buy and hold strategy

There is a critical need for players that can meaningfully tap the massive performing credit opportunity, and build access to very large international and domestic pools of capital.

The emerging performing credit market segment has the potential to offer stable and disproportionate fixed income returns to investors, as well as generate tremendous impact through the transformative power of capital markets to mid corporates.

The performing credit space has several tangible differentiators that make it an attractive investment proposition: high potential to scale — significantly higher number of investees than either traded or high-yield debt; superior Sharpe Ratio — high risk-adjusted returns owing to the significant premium available down the rating curve; low volatility — stable and predictable cash flows, backed by core operations (and not event risk), accrual based returns that steadily build up over time; and high impact — using the incentive of capital markets to build better governance, disclosures, market engagement, while at the same time aiding financial inclusion, employment and empowerment.

While some fund houses have started tracking this space actively, very few have specialised in building the core infrastructure and capabilities to sustainably grow in the performing credit space. To succeed and grow, fund houses need to heavily invest in (i) technology to access multiple external data sets on each potential investee, track performance, run algorithms to check for suspicious patters in data; and (ii) on field diligence to understand business models much better and monitor effectively.

Performing credit focussed funds have the potential to consistently generate inflation beating returns, with low volatility. By creating tailored products with high diversification, such fund managers can sharply limit the risk to investors. These funds, along with the ability to impact millions of livelihoods, can potentially help businesses create capital market track record which makes them less susceptible to capital market dislocations.

Performing credit funds are an excellent vehicle of accurately deploying foreign impact capital and are best placed to take advantage of a tremendous influx of ESG and impact capital being diverted into emerging markets across APAC, including India.

The writer is CEO, Vivriti Asset Management Company