HNIs steer clear of illiquid investments after Covid-19 outbreak

Market-linked debentures and credit risk funds - two products to have grown popular in the past two years - have fallen out of favour since the outbreak

Wealthy investors are shunning illiquid investments in the present uncertain environment, where cash is king.

Market-linked debentures (MLDs) and credit risk funds — two products to have grown popular in the past two years — have fallen out of favour since the outbreak.  MLDs are close-ended structured products — debt or equity-linked — which come with a lock-in of 2-3 years. For equity-linked structures, the underlying can be an index such as the Nifty, or a basket of stocks. The pay-off for investors could 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 40 per cent to Rs 17,000 crore in FY20 from Rs 12,246 crore in FY19, said 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 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 surged in the last few months.  “Investors do not get the benefit of diversification and are exposed to a single-issuer risk,” said Rohit Sarin, co-founder of 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 prominent issuers of equity-linked debentures. People in the know said the former has defaulted on payments and the latter is on credit watch, with ICRA reportedly downgrading multiple Edelweiss group firms this month. “You want to invest in an issuer with a top-notch credit rating, else you could lose your capital if the issuer becomes insolvent,” said Atul Singh, CEO of Validus Wealth, adding that strong NBFCs may still be able to raise money via debt MLDs.

Credit-risk funds — which try to generate high returns by investing in lower-rated papers ­— are the other casualties. These funds saw outflow of over Rs 19,000 crore in April, after Franklin Templeton’s wind-up move.

A number of AIFs focusing 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 for now, said experts.  “Quite a few AIFs focusing on high-yield papers — promising an internal rate of return of 15-16 per cent and investing predominantly in mid-sized firms — had hit the market in the last one year. These will find few takers now,” said Raghvendra Nath, MD of Ladderup Wealth.

Investments in PE and VC funds — where the typical holding period is 6-8 years — have lost sheen. Like all limited partners, HNIs have been hit by the dislocation in the equity and fixed-income markets. They are revisiting their asset allocation strategy, commonly known as the ‘denominator effect’, says Vivek Soni, partner and national leader (PE services), EY India.

“When public markets were expensive, PE made sense. They still make sense in pockets, but HNIs are better off allocating money in the listed space,” added Singh.