In an interview with ETMarkets, Ghosh who has over 18 years of experience across asset management said: “DBF-I has generated double-digit returns for the past 8 quarters, through quarterly cash coupons to investors. It has invested in over 35 businesses” Edited excerpts:
Can you walk us through the performance of the Alpha Debt Fund, which delivered double-digit returns in July?
Alpha Debt Fund is a sub-strategy of our second fund, Diversified Bond Fund (DBF-I). The fund has 2 other sub-strategies – Alpha Debt Fund Enhanced, and Emerging Corporate Bond Fund.Launched in mid-2021, DBF-I was our second Performing Credit strategy. It gathered INR 1,700 crore from insurance companies, family offices, corporate treasuries, and HNIs.
DBF-I has generated double-digit returns for the past 8 quarters, through quarterly cash coupons to investors. It has invested in over 35 businesses.
The predominant strategy has been cashflow-backed lending, supporting the growth of businesses. Examples are as follows –
– Augmenting working capital for manufacturers – fertilizer, smart meters
– Mezzanine financing for infrastructure asset operators – roads, airports, ports, telecom
– Capex financing for services firms – integrated logistics operator, managed services provider
– Growth financing for financial services providers
– Product development for profitable SaaS firms
Over 90% of the portfolio is rated by credit rating agencies, with median investment-grade (BBB+) rating. In the world of investing in illiquid credits through a closed-ended fund, we believe an external unbiased view of the health of our portfolio serves investors with the closest proxy of ‘marking to market’.
Can you explain the investment philosophy behind the fund?
DBF-I was launched in mid-2021 when the country was recovering from disruption in economic activity, a high degree of uncertainty about what lay ahead, while markets were aflush with capital and optimism about new-age tech-led business models, and inflation (globally) was a worry at the horizon.
Policy pushes and the Union Budget (Feb’22) indicated that govt. would lead with spending on infrastructure creation, which was to improve income generation, fuel household consumption, and pave the way for the private sector to feel encouraged to invest and expand capacity.
That was the backdrop for the fund to invest in businesses for 2-4 years, starting in 2021-22. Our view was that businesses which would power economic recovery would likely be in or in adjacencies of
– infrastructure creation – roads, urban infrastructure, energy sufficiency and decarbonisation
– urban consumption, which has been on the right side of the ‘k’ shaped recovery as it was being perceived back then
– digitalisation of services
We also envisaged that liquidity conditions would tighten sometime over the life of these investments, given the excesses around the world.
Hence our overarching investment thesis was to invest in businesses for growth, while being repaid through cashflows generated and strived to avoid depending on events – refinancing, equity capital raise, asset sales – as sources of repayment.
As for the businesses themselves, we eyed a universe of c.4,000 mid-sized firms with revenue between INR 500 – 5000 crore, which have managed businesses profitably through the past several years.
These have working capital lines from banks, and usually banks also partly fund capital expenditure, albeit with increasing equity contribution as we go down the scale.
Who would be the ideal investor for this fund and how does a debt fund help with portfolio diversification?
This strategy is suited to investors who could set surplus capital aside for c.4-5 years, seek quarterly income through interest payouts, and c.500-600 basis points of premium (pre-tax) over quality fixed income, with low volatility compared to more exotic investment strategies (e.g. investing in startups, distressed businesses, etc.).
Importantly, in times like these where we see equity allocation in portfolios having defied portfolio allocation strategies, Performing Credit serves as diversification owing to its low correlation to equity markets.
In cashflow-based lending, the health of the portfolio’s underlying investments is predicated on economic activity, sectoral metrics, and idiosyncratic events pertaining to the investee, but not gyrations of the broader market.
DBF-I is closed for subscription, and we launched its sequel DBF-II earlier this year.
There is increasing speculation about a rate cut by the US Fed, which could lead to a rate cut by the RBI in India. What trajectory do you foresee for interest rates, and how will this impact your funds?
That’s the street consensus, and the feeling this time is stronger than ever, backed by tepidity in economic and inflation data in the US.
That said, we keep cautioning ourselves time and again that we live in very uncertain times, especially geopolitically, much of which has a bearing on economic activity, supply chains, govt. and defence spending, commodity prices, immigration / labour supply, and more. Conceptually, every nation gunning for self-sufficiency should be inflationary.
Economic conditions in the developed world, on the other hand, have been weakening. Add to that divergence in action between major central banks, forced by domestic conditions.
So, the ‘soft landing’ narrative might get tested.
For India, while we’ve thus far stood out on the count of economic resilience, fiscal prudence, and general currency stability, it may not be sustained.
Q1 results showed slowing consumption, earning weakness (ex-BFSI), and generally worsening asset quality of banks and FIs pointing to low individual spending propensity in times to come.
And hence, the rate cuts, whenever they happen, might not be as happy outcomes as the world is making it to be. It might be accompanied by slowing growth and market corrections.
As for Vivriti Asset Management, we find it more practical to predict how our investee businesses would perform over the next 3-4 years, than trying to predict what markets and central banks would do.
So as a policy, while we’ll hold a view on macro conditions, we would spend more time thinking about what bearing they might have on business segments that our current and prospective investees operate in.
Hence as part of our investment thesis, we test the serviceability of debt under a spectrum of such conditions, without wagering which macro scenario will finally prevail.
How do you manage credit and interest rate risk in the fund?
In strategies like DBF-I and II, which are closed-ended funds, investing predominantly in illiquid credits for 2-4 years with the intention to hold to maturity, interest rate risk manifests mostly in reinvestment risk.
The investments amortise and give back capital, which we redeploy, and this happens for the first 24-30 months of the fund.
Given the trajectory of interest rates, it is likely that they are lower 12-18 months from now when we seek to reinvest capital.
This must be contextualised though. Unlike quality fixed income (G-sec, AAA) where YTM varies sharply with policy rates and macroeconomic conditions, the spread over those in A and BBB rated markets vary less violently.
Hence, they neither compress nor rise as much, mostly owing to low participation in these markets. That said, we factor this in constructing the portfolio, to buffer for lower rates in the later part of the fund.
Credit risk is key. To that end, we lay emphasis on the following –
– The business sector we invest in should either benefit from foreseeable tailwinds, or at least not be susceptible to worsening macro conditions. It shouldn’t be in the eye of policy headwinds. Research is key to our decisions here.
– On the investee itself, our view is built through in-house diligence, which covers several intangibles – governance and disclosure standards, promoter and management incentives, decision-making apparatus, etc. – in addition to market position, business strengths, financial position, and capital access.
– Deal structuring, including rights and obligations, covenants, and security structures, helps mitigate risks to our going-in investment thesis.
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Importantly, post-investment tracking is critical to identifying and managing risk in the portfolio. Towards this, at Vivriti Group we have taken a dual approach of –
a) frequent and ongoing engagement with promoters and management, and
b) using our data sciences backbone that taps into scores of public data sets (like GST, EPFO, MCA, legal cases, listed comparables, etc.) and helps assimilate large swathes of data (e.g. bank statements), to keep us ‘live’ with state of affairs of investees in our portfolio.
It is a myth that closed-ended funds that employ hold-to-maturity (HTM) strategies are passively managed. Because there is no market exit owing to the illiquidity of these investments, it is imperative to track and recalibrate the investment thesis, have the ability to act in time through well-structured rights, and triangulate issues in time to be able to do so.
Speaking about the industry, what kind of growth have you observed in the appetite for Debt Funds over the last 4-5 years? What is fuelling the demand?
As a team, we managed Cat-II credit funds that launched in 2014, when the concept of Performing Credit or mid-yield debt wasn’t in vogue.
When we launched our first fund at Vivriti Asset Management in 2019, the predominant strategies were venture debt and special situations. The past 4-5 years have indeed seen strong growth in debt funds, which I’d attribute to the following –
Asset supply – we are a country of thousands of mid-sized enterprises, most of which are growing at higher-than-accrual rates, and some are expanding capacity, pronouncing the need for debt capital. Data validates that bank lending to the industry over the past 10 years hasn’t kept pace with this growth, focusing instead on lending to individuals. Also, the general nature of bank lending to mid-sized corporates is policy-driven and regimented, lacking flexibility thereby, which is key for such businesses navigating business realities. Non-banks have been restricted on end uses they can fund on account of either bank parents (where that’s the case), or asset-liability woes since 2018, triggering a pivot to retail in several cases.
Capital supply – change in debt mutual fund taxation was significant, creating a level playing field between investment vehicles, and removing distortions in post-tax returns.
Industry landscape – there has been heightened interest from financial services houses to enter the Performing Credit segment, including from ones whose flagship asset class wasn’t credit. This has created awareness for the asset class, provided investors with choice, and importantly – helped investors benchmark between investing strategies being employed by managers to achieve returns. This risk benchmarking will probably evolve over time, and eventually help further segment the somewhat broadly used term ‘Performing Credit’.
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