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The Perfect Storm of Private Credit for India: Will it be Rains or Thunder Striking?

Warren Buffett, renowned for his sagacious investment strategies, demonstrated a masterclass in the use of convertible securities during the 2008 financial crisis. When Goldman Sachs needed a capital infusion, Buffett invested $5 billion in Goldman's preferred stock with a 10% dividend and warrants to buy additional shares. This strategic move yielded significant returns, underscoring the power of structured credit. What was considered a "special situation" investment in financial jargon has evolved into a full-blown asset class, highlighting the potential for structured credit to deliver outsized returns with relatively managed risk.

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The Rise of Private Credit as an Asset Class Globally

Private credit has emerged as a formidable asset class worldwide, with firms like Apollo Global Management and Athene leading the charge. The private credit market in the United States has seen substantial growth over the past two decades. In 2005, the estimated size of the private credit market was around $100 billion. This included various forms of private lending, such as mezzanine financing, direct lending, and distressed debt. By 2020, the private credit market had experienced explosive growth, becoming a significant component of the broader credit market. The estimated size of the private credit market in 2020 was approximately $900 billion to $1 trillion, reflecting a nearly tenfold increase.

Traditionally dominated by banks, the credit market now sees an influx of private equity (PE) firms racing to establish their foothold. The allure is clear: structured credit offers a compelling reward-to-risk (R/R) ratio, making it a favoured choice among hedge funds and institutional investors. This shift is fueled by the search for higher yields in a low-interest-rate environment and the flexibility private credit offers in structuring deals to mitigate risk while enhancing returns.

India's Unique Landscape: Converts as Catalysts for Massive Returns

In India, the financial ecosystem is characterized by two extremes: on one side, a robust bank loan market covering about 90% of capital requirements, and on the other, a vibrant growth equity market, particularly for early-stage ventures. However, a significant gap exists in the middle market segment, which remains underserved and presents a ripe opportunity for private credit.

The BSE (Bombay Stock Exchange) orphans—mid-sized companies with stable growth, margins, and cash flows—embody the potential for high returns. Often overlooked by traditional lenders and equity investors, these firms are ideal candidates for private credit. The real opportunity lies in structuring credit in a flexible manner so that the business can take advantage of the timing of cash flows based on the business cycles while facilitating growth across four critical parameters: topline organic growth, margin improvement, capital intensity, and strategic capital allocation. Investors can also achieve high returns due to their optionality on the upside of earnings increase—a win-win for all.

The Big Question: Why Isn't Everyone Cashing In On The Private Credit For India Opportunity?

Despite the apparent opportunities, several challenges deter widespread participation in India's private credit market.

  1. Mispriced Assets: Identifying the dollar value of cash flow mispricing requires a deep operational understanding of the business combined with a sophisticated multi-asset hedge fund approach. This dual expertise is rare, creating a significant entry barrier.

  2. Origination is Key: Effective origination is crucial for success. Having "feet on the street" is essential to accurately price optionality and uncover hidden value. The ability to originate deals and structure them correctly can be the difference between achieving a 20% return and a 40% return. This local presence and nuanced understanding of the market dynamics are pivotal in navigating the complexities of India's mid-market segment.

Conclusion: Navigating the Perfect Storm

The rise of private credit in India is akin to navigating a perfect storm, where the convergence of mispriced assets, untapped market segments, and the need for sophisticated structuring creates both immense opportunities and significant challenges. As global trends demonstrate the potential of private credit, India's unique market dynamics offer fertile ground for substantial returns. However, success will hinge on bridging the knowledge gap, effectively originating deals, and structuring investments to balance risk and reward.

For investors ready to embrace this storm, the promise of high returns is real, but so are the demands for expertise, local insight, and strategic agility. Whether this storm brings rains of prosperity or the thunder of unmet expectations will depend on the ability to navigate these challenges with precision and foresight.

Disclaimer: In the article "The Perfect Storm of Private Credit for India: Will it be Rains or Thunder Striking?" above - Any views, comments or communication (above or in the past) should not be construed to be investment advice by Alternative Growth (hereafter referred to as “AltG”) in any form whatsoever. AltG does not make an offer to sell or solicit to buy any securities.


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