Private debt is set to grow tenfold in the next five to 10 years, according to Nitin Jain.
Investment funds including Blackstone, Blackrock and Lone Star are now focusing on private debt, with most of them growing this portfolio at a faster rate than their private equity portfolio, said Jain, founder and chairman at the Neo Group, which manages money for high-net-worth individuals.
Private debt, or loans to companies by private investors, can deliver equity-like returns but with much lesser volatility, he told BQ Prime’s Niraj Shah in the special series 'Where Do Millionaires Invest?'. While it doesn’t offer unlimited upside, it covers the downside, he said.
According to Jain, the asset class is gaining traction in India as there are few alternatives to traditional fixed income assets. “Despite G-sec (government bond yields) going to 7.5%, every rate is still 5.5-6%... If you are able to generate anywhere between post tax 12% and 14%, it's a massive spread over what you can deliver. So, I do think it will become a very, very big asset class."
Investing in private debt goes beyond putting in capital in the company. Jain highlighted that it helps in helping companies solve problems of financing and setting up governance structures.
“Because those problems cannot be solved without skill and without capabilities. You are not only bringing in capital, but you are also bringing in capability," he said. "And hence you are pricing yourself much more than a pure fixed income instrument, but you are creating more value for the operating company, than what a pure debt is doing."
Watch the full show here:
Edited excerpts of the conversation:
Nitin, you have a very rich history of managing enormous amounts of wealth and now you have founded your own firm? What is the core driving principle for investing your client’s money or advising them on their money?
Nitin Jain: We are running two businesses -- multifamily office practice and asset management.
In multifamily office business, most of our clients are young entrepreneurs and businessmen. Their biggest need is to preserve the wealth they have created. As a wealth manager I am not trying to create wealth for them, but is looking for wealth preservation. They are looking for some growth and that is where we come into play. We help them not divert their attention from the core businesses, take care of their wealth and let it grow.
Our core focus always is about long-term asset allocation.
A lot of people tend to believe product selection is the key driver of alpha. We have always stuck to asset allocation. If you can be very disciplined about asset allocation, long term returns are always superior. So that's what we advise our clients.
The second key point is diversification.
Unfortunately, in India, you cannot do a lot of diversifications internationally because of issues around capital account, etc. A lot of new products are created in the alternative space, which is a very good diversification. This is because the correlation with existing portfolios is much less due to new supply and fund managers are coming in. So, we use the alternative portfolios along with the fixed income portfolios and whatever little we can invest internationally with the spectrum that is available. This is how we help our clients to diversify.
So long-term asset allocation and diversification are the core principles which we advise our clients.
So, in your experience for whatever quantum of wealth, asset allocation would be a bigger driver of wealth creation than the selection of products?
Nitin Jain: Absolutely! Studies indicate 80% of the alpha in most portfolios can be attributed to asset allocation rather than fund selection, product selection, or security selection.
Wouldn't that be a part of asset allocation too?
Nitin Jain: Let me give an example. You buy a particular stock. But, the amount of money you make is not because of that stock. It is about how much you bought. So, how much you bought is a more important decision than which stock you bought. Capital allocation carry more weightage to our thought process than specific individual decisions.
How you differentiate is purely stock market investing, it's about how much allocation you make to individual stock. And in this case, it's about what allocation you made in a particular asset?
Nitin Jain: Absolutely! Whether it's equity. Whether it is debt. Whether it is alternatives. Whether it's international assets, so on and so forth.
What's your current average asset allocation percentages? What I got from a couple of other conversations on this very series was that the ultra HNIs and the really smart investors, even if they didn't redeem, had stopped making large fresh allocations to equities, local or international, from December. They have been on the backfoot. Would you assume that some of the really smart guys are sitting on the sidelines?
Nitin Jain: We will know whether they were smart or not after 10 years. But it's true. The markets were heated, no doubt about it. Even we were advising clients not to incrementally allocate. Some of these calls will go right, some will go wrong.
The markets has got overheated due to the kind of retail flows that you are seeing. It's unheard of, earlier.
The data might surprise you. Three years back, that is, pre-Covid, around two-and-a-half to three lakh demat accounts were getting opened every month. Six-months back, it was 50 lakhs new accounts in a month. So, from three lakhs per month to 50 lakhs a month.
That is a reflection of the euphoria in the market!
It's also a reflection of the great things that are happening in the market. It is also a reflection of some level of over optimism getting build in the market. Clients, including us, are reasonably cautious in going into this kind of a phase.
Let's focus on equities for a bit and then we'll try and focus on the overall asset allocation strategy. Since equities drive a large part of most people's portfolios, is there a change in how you think about allocating to equities now, versus what you probably thought in December? I would love to understand how you are thinking about equities in general?
Nitin Jain: The frameworks we like a lot is looking at history and looking at earnings yield versus the bond yield, in any particular markets.
For example, at a Nifty level, if I have to look at the aggregate earnings today, I think the earnings yield will broadly translate into 5.50-5.75%. Whereas the 10-year government security is around 7.50%. So, earnings yield is trailing by around 175 basis points to the government securities.
In the worst-case scenarios, the spread has not gone below 100bps. If the worst case is to play out, then there is a downside of about 10% from the current levels, unless the yield on the government securities to move up. But, that is not our base case hypothesis.
Having said that, 5% to 10% downside is a given in equity markets making some of the high-quality stocks and some good high quality fund managers become a fair game. So, we are evaluating opportunities to add.
We are currently slightly 'below weight', but we are looking to add at possibly every dip from here on the equity position.
Can it go down, of course! But, our clients are not looking for a return in the next one quarter or two quarters. We are looking at generating returns over decades. It's a slightly different world that we live in.
Even from a three to five-year point of view, the risk-return is starting to become favourable but there can also be a 10% downside. However, in equity, we should make such an assumption at any level.
While equity is one part, you are looking at a multitude of different products, asset classes as things stand. Can you tell us the asset allocation percentages for an average client with a basic framework? How much to equities? How much to fixed income? How much of structure products may be international? Can you tell us a bit about it?
Nitin Jain: It's very difficult to say because for every individual investor it's different. The way to think about this is, we are currently slightly 'underweight' on equities. We will correct over the next one and one-and-a-half months.
We really like fixed income. We have got into a space where both duration as well as credit has started to look good. Can yield go up a little? Of course, 7.6% can go to 8%. But now you have to start thinking about the risk-reward. People were jumping over each other to lock when long term yields hit 6.50%. It's is now 7.6-7.7%. The risk-reward is so much better, now. The way to think about returns in fixed income is not very different from equities. However, there is a lack of rigour in fixed income space that we see in equities because of lack of research. We also want to come up with our own fixed income research over a period of time.
There are a lot of very high quality, fixed income instruments, high quality credit that is available, both in terms of duration as well as credit spreads. We can create very high-quality portfolios and over the next three to five years deliver 10% to 12% return purely in fixed income.
Compare this with money lying in fixed deposits, which is probably generating 5.50–6.00% return. In fixed income, we generally benchmark versus FDs. In FD, If you are making 5.50-6.0%, and in fixed income, we can deliver anywhere between 9-10%, it's 400 basis points spread.
So, we think fixed income, over the next three to five years is going to be more interesting asset classes than what it has been over the last three or four years. We are very focused on that.
The third category is alternatives in which we want to do a lot of work. In the next five to six years, my view is that alternative investment funds might become as big, if not bigger, than a lot of traditional mutual funds, in terms of revenue pool for asset managers.
I am distinguishing between the AUM and the revenue. The AUMs are higher in traditional assets, but the fee is lesser whereas the fee is much higher on the alternate side. From market size point of view, I think alternatives are going to go much more than the mutual fund industry.
By alternatives you mean equity AIFs or all kinds of AIFs? What are the kinds of AIFs because a lot of people may not even know about it?
Nitin Jain: I will just come to that. Currently, we are on three-and-a-half lakh crores of AUM in alternatives. This is a big jump for an industry that we started in 2012. It is now growing at 140-145% CGR and there are a lot of very, very high-quality fund managers who are coming out with products.
Five years back, I did not see such high-quality fund managers. Now we can allocate to these fund managers as there's governance, performance track record, and strategy which are meaningfully differentiated. What we used to see was the same strategies that were being done on mutual fund platform were replicated on the AIF. This does not mean a lot to asset allocators as he need a correlation and here there is much less than one to allocate for diversification of core portfolio.
There are four primarily categories in AIFs. One is private equity. It is reasonably well understood in India. It's also matured with two or three cycles. Family net worth has also started to go into private equity versus five years back when most of the family offices and rich people did not have access to private equity. But now, a lot of HNIs and rich families have started to get access to private equity in India.
The second category is private debt. It is a very unique, emerging asset class not only in India, but even globally. Private debt is growing much faster than private equity globally and have players like Apollo, Blackstone, Blackrock, Lone Star, among others. Most of them will be growing their own private debt portfolios at a faster rate than their private equity portfolio. We are starting to see this happening in India, but very few people have done this successfully in India.
We have already launched such a fund. There are other couple of high quality private debt funds in India. These funds can deliver equity like returns but with much lesser volatility.
What is this product and how does this work, for example, can you tell us a bit about it?
Nitin Jain: When you think about equity, there are listed equity and there is private equity. What is private equity? Here you identify a very special situation, you fund the company at a much lower valuation, but you also add to the company. So, private equity is not just giving money to the company. It is doing a lot for that, by being on the board, by helping the promoter think about the firm, by giving him a network, etc.
To think about private debt, the framework should be similar. In normal fixed income, what do you do, you just give money. In private debt, you understand the situation. You work with the promoter. You put governance structures in place. You help the firm solve very specific problems of financing. And because those problems cannot be solved, without skill and capabilities, you are not only bringing in capital but are also bringing in capability and hence are pricing yourself much more than a pure fixed income instrument. You are creating more for the operating company, than what a pure debt is doing. Hence, the returns are superior.
In some sense, it’s a mirror image of private equity. But, what you get is debt like returns. You don't have unlimited upside, but are very well covered on the downside.
For example, we do only Ebita positive companies. So, EV to Ebita, after our debt infusion should never be more than three to four times. Our asset cover should always be more than two times. Thus with such cover, chances of losing capital go down dramatically. If we generate anywhere between 16% to 24% returns then you are talking about equity like returns, and maybe somewhat superior to equity but with a lot of controls and covenants in the organisation. So that is private debt.
I think this will be an asset class that we should watch out for in the next five to 10 years. This will become 10x of where we are right now.
Our series we are calling it 'Where Do Millionaires Invest?' Are the millionaire clients investing heavily into such products?
Nitin Jain: In the last organisation that I was running, we had raised around Rs 20,000 crore in these funds. There are a couple of other organisations that are raising a lot of money. So, I will not say that in allocating a lot of money, but the incremental appeal for these funds has gone up dramatically in the last few years. I see that happening in an exponential way over the next few years.
So that's interesting, it's something new. I don't think we have heard about this too often. So, thanks for bringing that up.
Nitin Jain: So just to close the framework. The first question was, what are the four segments of alternative investment funds. They are private equity, private debt, hedge funds, and real assets.
Hedge funds most people understand what they are. But in India, hedge funds are still struggling because of the regulatory frameworks which are not amenable for tax issues.
Real assets are basically where instead of buying companies and investing in companies, you actually buy actual operating assets. Like a highway, a road. You can actually buy a port! You can buy an airport, REITs and InvITs etc. They are also part of the real estate spectrum and have become very, very interesting to some of our high-net-worth individuals.
Just now, yield and fixed income is driving a lot of these ideas. We like equity, but due to volatility you cannot allocate beyond a point. A lot of AIF instruments provide returns which are superior, risk adjusted with a lot of stability to portfolios.
That's crucial as well. I am trying to understand that what you are talking about in terms of private fixed income been very different from the traditional understood fixed income? Do you reckon that the size of these investments will grow? Are people looking to open up their purses and write cheques for stuff like this in a big way?
Nitin Jain: I think so. Every category which is new, has to be discovered, and somebody has to drive the discovery.
We intend to drive this discovery fundamentally. So, there are three or four high quality fund managers who are doing this job in India right now and the kind of traction that we are seeing in private debt makes you believe that over the next four to five years, there's going to be a very large asset class.
In fact, for a new asset class, the kind of reception that we are seeing, even for our fund, has actually been quite positively surprising. So, this is the kind of opportunity that people have been waiting for in India, because there are very few alternatives to traditional.
If you are able to generate anywhere between post tax 12% to 14%, it's a massive spread over what you can deliver. So, I do think it will become a very, very big asset class.
Richie Rich have been, since post Covid, very keen and invested heavily in private markets. Is your experience similar and how do you think it shapes up now that we know that private markets also have seen a bit of a reset of valuations?
Nitin Jain: Every asset class is cyclical. Fundamentally, some are short cycles, some are long cycles. One of the key fallacies of the market is that people recent performance too much. There is too much of anchoring around the past three-year performance or sometimes even six-month performances.
I think private markets went through that and I think, especially in the unlisted space, there's been a lot of excitement in the last one-and-a-half to two years.
But what has happened, and I will tell you something very interesting. It's some math’s at the end of the day, it's a little bit of behaviour, but a lot of it is driven by maths.
Just imagine companies are saying will not be profitable for the next five to six years, but will make profits after that. Brilliant companies. Companies driven by exceptionally high-quality promoters. Once the interest rates go up, what happens is the of cash flow after seven years, eight, 10 years dramatically drops.
It's not just in India, but globally, every company, which was not profitable, but was projecting cash flows after five to 10 years, as the interest rates rose, have corrected by 30-40%. It has to, as interest rates moved from zero to 3.5% for every dollar. That is a mathematical correction that you need to go through just to discount the future cash flows. This is especially true when the markets go up, and more so when it go down as markets tend to overreact.
That is what happened to private markets, too much euphoria. I still believe there's a lot of future for these companies. But in this way, some of these companies were sold in the HNI market, particularly when the retail market was not good. I think at some level, the suitability of the client’s objectives vis-a-vis what you are advising has created a little bit of disillusion in the private markets.
I have seen these cycles many times, some clients did invest in private markets. Some of those companies have corrected but they will come back, some of these companies might or might not come back. So again, you have to discriminate companies, private market is a large asset class. Let's have high quality companies, I am very convinced that we will do extremely well. But let's say you are in companies which didn't have the strength of the business, which did not have strong funding around them. Who knows how strongly they might be able to come back.
We will keep a watch in that space. There's pain in the next three to six months. There's going to be more pain and lot of people who might think that this is the end of it. But, where we come from, we feel it’s not over. Three to six months of enormous pain in the private markets and that will create the opportunity for us to identify some high-quality stocks.
Interesting, so is it safe to assume that from your perspective, where your clients might be looking to invest through you and when you might be inclined to invest them is keeping fixed income at the core, and then everything else becomes satellite but largely fixed income?
Nitin Jain: Fixed income is a core driver, for sure. Depending on your risk appetite, we want to start going a little more aggressive on the listed equity space.
As the markets keep on going down, alternators we are always excited. This is a satellite portfolio because alternatives cannot be more than 15% to 20% of the portfolio, but it also creates meaningful alpha.
We are continuously looking for high quality fund managers. But the key driver is you cannot have the same strategy. I don't get any alpha because of nearly the point 8, point 9 correlations with the market. I need point two, point three, or point four correlations, to give diversification to my customer.
So, people who are able to create strategies which have low correlation with markets. For me, there are very interesting. opportunities.
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