Wealthy investors shun illiquid investments amid covid-19 outbreak

Most of the issuers are NBFCs rated ‘AA’ or below, and carry a high risk of default
Wealthy investors are shunning illiquid investments in an uncertain economic environment where cash and liquidity are king. 

Market linked debentures (MLDs) and credit risk funds -- two products that had grown popular in the past two years --- have fallen off the map post the covid-19 pandemic.  

MLDs are close-ended structured products, debt or equity-linked, that come with a two to three year lock-in. For equity-linked structures, the underlying can be an index such as Nifty 50 or a basket of stocks. The payoff for investors can be in the form of a fixed coupon or participation rate. Debt MLDs typically pay a coupon of 7-11 per cent. 

MLD issuances were expected to grow about 40 per cent to Rs 17,000 crore in FY20 from Rs 12,246 crore in FY19, according to a CARE Ratings report last year. As on June 20, 2019, the total rated volume for principal protected-MLDs increased to Rs 45,000 crore from about Rs 37,000 crore at the end of FY19. 

While most of these products are supposed to have an element of capital protection built in, the risk of the issuer defaulting has grown manifold in the last few months. 

“Investors do not get the benefit of diversification and are exposed to a single-issuer risk. That can be a challenge in this environment,” said Rohit Sarin, co-founder, Client Associates. 

Most of the issuers are NBFCs rated ‘AA’ or below, and carry a high risk of default. Edelweiss and Reliance Capital, for instance, were two of the prominent issuers of equity-linked debentures. According to sources, while the former has defaulted on payments, the latter is on credit watch, with ICRA reportedly downgrading multiple Edelweiss group companies this month. 

“You want to invest in an issuer with a top-notch credit rating, else you can lose your capital if the issuer becomes insolvent,” said Atul Singh, CEO, Validus Wealth, adding that a few good NBFCs may still be able to raise money by issuing debt MLDs. 

Credit-risk funds -- which try to generate high returns by investing in lower-rated papers -- are another casualty. These funds witnessed outflows of over Rs 19,000 crore in April after Franklin Templeton wound down six of its debt schemes. A number of alternative investment funds (AIFs) focused on the debt segment, too, had launched credit-oriented funds in the past year hoping to benefit from high yields. The demand for similar launches is likely to be muted in the near future, said experts. 

“Quite a few AIFs focused on high yield papers, promising an IRR of 15-16 per cent and investing predominantly in mid-sized companies, had hit the market in the last one year. These will find few takers now,” said Raghavendra Nath, managing director, Ladderup Wealth. 

Investments in private equity and venture capital funds --- where the typical holding period is six to eight years --- has lost its sheen. Like all LPs, HNIs have been impacted by the dislocations in the equity and fixed income markets and are probably revisiting their asset allocation strategy, commonly known as the ‘denominator effect’, says Vivek Soni, partner and national leader – private equity services at EY India.   

“As VC and angel fund investments have long hold periods and are illiquid in nature, the HNIs may not reduce their holdings and instead take a call not to make any fresh commitments,” said Soni.          

“When public markets were expensive private equity made sense. They still make sense in pockets but HNIs would be better off allocating money in the listed space, where valuations have come off significantly,” added Singh. 

Last month did not see any new PE/VC fund raises, the first time since many years that there has been a nil monthly PE/VC fund raise. This can be partly attributed to the lockdown and partly to the ‘wait and watch’ approach adopted by most LPs, said Soni.   

In 2019, Indian PE/VC investments recorded an all-time high of $48 billion. In terms of value, investments increased by 28 per cent over 2018, while the deal volume rose 35 per cent.


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