Investors are increasingly turning to private credit and structured debt to target double-digit returns as traditional fixed-income yields remain modest. These high-yield instruments often carry greater credit risks compared to conventional bonds, reflecting the higher interest costs paid by companies unable to secure bank financing. Investors should carefully assess the underlying security of these bespoke deals.
Indian investors are increasingly looking beyond traditional fixed-income avenues like bank deposits and standard corporate bonds in search of higher returns. This shift is driven by a desire to outpace inflation and minimize the impact of income tax on interest earnings. Consequently, alternative debt instruments such as private credit, structured deals, and special situation funds have gained popularity by offering potential annual yields in the 12% to 14% range.
Understanding the Risk Premium
The fundamental premise behind these higher returns is the risk-reward trade-off. Companies opting for private credit or structured debt often do so because they are unable to secure funding from traditional commercial banks at lower rates. This could be due to their early stage of business growth, inconsistent cash flow history, or exposure to volatile industry sectors. When a company offers a significantly higher interest rate, it often reflects the lender's perception of increased default risk. Unlike government bonds or high-rated corporate papers, these bespoke instruments lack the same level of liquidity and credit assessment transparency.
Structural Differences in Debt Deals
Recent market examples highlight the diversity of these offerings. Some structures, such as Compulsory Convertible Debentures (CCDs), provide an annual interest payout with the added feature of conversion into equity, tying the investor’s potential gain to the company’s future valuation. Others, like certain Non-Convertible Debentures (NCDs), are designed purely for yield, targeting specific short-term internal rates of return that outperform standard market offerings. These structures are often customized to meet the specific capital requirements of the borrower, providing a level of speed and flexibility that is frequently missing in conventional bank lending.
Why Banks Have Stepped Back
This growth in the private credit space is partly a result of shifts in the banking sector. Since the global financial crisis, stricter regulatory norms and increased capital requirements have led many traditional banks to adopt a more conservative lending approach, particularly toward smaller or unrated entities. This created a financing gap that private credit players and alternative investment funds are now filling. While this provides companies with necessary capital, it transfers the credit risk directly to the private investor.
Investors considering these opportunities should monitor the underlying credit quality of the issuer and the strength of the security collateral backing these deals. The next critical update for those in this space will be the track record of repayments as these instruments mature, which will clarify whether the higher promised yields can be consistently delivered without significant credit events.