Structured to catch the HNI eye

Debt can be an interesting asset to invest in. It is an asset class with a varied bouquet of choices to excite investors looking for a wide spectrum. You can pick the safe G-Secs with tepid returns, corporate bonds of different credit ratings, or the extremely risky junk bonds with mouth-watering returns.

You will also find that the mis-pricing of risks by the market, or high demand, lead to better risk-adjusted reward. Fund houses have also created more complex debt instruments and many such tailor-made products are gaining currency with high net worth individuals (HNIs) as an alternate asset class.

One such popular option is structured debt, which is a loan with flexible terms. For example, the repayment may be a balloon payment at the end of the tenure rather than as regular EMIs. Likewise, the interest may be paid at convenient intervals rather than at pre-set periods.

The intent of the instrument is to customise the loan to meet the borrower’s needs. For instance, property developers may take a loan for construction and may only pay the interest along with the principal after, say, two years. The lenders are given a better rate of return for the flexibility offered. While G-Secs yield 6.6 per cent, structured debt can provide returns of about 20 per cent.

These products have been quite popular in the real estate sector where private equity funds offer debt that is customised — tenure, repayment schedule and other terms — to the specific needs of a developer.

In some cases, a part of the loan may also be converted to equity in the project, to lock in a higher upside. Investments from HNIs are through SEBI registered Alternate Investment Fund (AIF) and the minimum capital commitment is ₹1 crore.

From the borrower’s perspective, customised debt is a boon and is increasingly finding takers in different sectors. For instance, the SME segment, lacking funds, appears hungry for the product.

“Banks have become guarded and funding from bankers has become a challenge,” says Nazar ISAK, CMD, Manna Foods, based in Chennai. Banks are taking an extremely critical view of any approval and do not want any risk in lending. “This has been a major issue for a start-up or small and medium-sized companies, which have plans to grow but attract less or no support from banks,” he says. Another advantage for a borrower is that while traditional lenders look only at the past performance and collaterals of the company, structured debt funds consider the future projections too. This makes it more a hybrid-approach when making a lending decision and assessing potential risks.

Structured debt also offers easy repayment terms, which may reduce the risk of late payment or default. With these advantages, borrowers do not mind paying a higher rate of interest as they are able to generate value with the investment in their business.

The demand for debt is only expected to increase, especially if the lenders add value and appreciate the performance of the company and structure the debt to suit the company, says Nazar.

Besides the coupon, another potential attraction is that structured debt may look to capture the upside through equity. Typically, bulk of the returns is from yield, with a small portion, say, 10 per cent, as warrants or equity.

And with private debt at the cusp of significant growth, the demand and the potential for high reward have ignited strong institutional interest in launching such products.

Avendus Capital launched a ₹250-crore Category II AIF to offer structured credit to prominent mid-market companies. The fund will invest in instruments yielding mid-teen returns. Other firms that have started, or are in the process of creating structured credit platforms, include Baring Private Equity Asia, Edelweiss Group and Avista Group, according to VCCircle. Another notable player that entered the space recently is UTI AMC, which launched a private debt fund. It hopes to deliver superior risk-adjusted returns by offering customised structured credit solutions to corporate clients.

An early mover in the space is Chennai-based Anicut Capital, which started in September 2015. Its ₹250-crore Grand Anicut Fund lends to the SME segment.

IAS Balamurugan, Managing Partner of Anicut Capital, says the fund aims to deliver returns of 20 per cent through short-term (under 18 months) loans to SMEs. The alpha on the returns comes from the team’s understanding and experience in working with the target segment.

For example, there is not much publicly available data on SMEs. In some clusters, there may be a lot of cash transactions and there could be governance risk with the promoter. Credit assessment requires hands-on knowledge of regional and specific risks, gathered through a network of connections.

Balamurugan says that many nuances beyond financial ratios and compliance must be evaluated. “You need a network to check aspects such as how confident existing investors are, whether the firm has a succession plan, what is the feedback of vendors and suppliers and then assess the capability of the promoter,” he stresses.

The niche segment focus has kindled the interest of many HNI investors and family offices. “Structured debt to SME is an interesting asset class with which funds can build a portfolio to suit different risk appetites and return trade-offs,” says Balamurugan.

Sudhindra Ballal, Portfolio Manager, Acsys Investments, which focuses on investing in start-ups, has bet on Grand Anicut Fund since it meets its criteria for managed alternate investment vehicles.

He says that he has found multiple benefits with investing in such a product. One, it addresses the credit requirement of SMEs, a largely under-penetrated segment. Two, the loan product can only be customised by someone “with their ears to the ground to feel the pulse of the sector.” He adds that the SME segment is not deeply penetrated and cannot be measured by standard yardsticks.

He notes that therisk is contained by a risk management framework and the coupon offered is also higher. And the risk-adjusted return is also good, he notes.

The AIF has seen good interest from investors and has raised over ₹300 crore, and is also closing six months ahead of its scheduled time.

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