Transcript

Nippon India’s Private Credit Playbook | Fund Manager Interview | Rahul Apte

Aravind Ravindran: Hello and welcome, everyone, to yet another episode of the fund manager interview with PMS Bazar. I am your host, Aravind Ravindran, and today we are privileged to have with us Mr. Rahul Apte, Co-Fund Manager for Private Credit at Nippon India Alternative Investments. Mr. Apte has over 16 years of extensive experience in wholesale debt businesses and brings a deep understanding of all facets of the deal life cycle management, including deal sourcing, client development, credit assessment, monitoring, and managing exits. Mr. Apte holds a bachelor's degree in mechanical engineering from the Indian Institute of Technology Madras, and he furthered his education with an MBA in finance and marketing from the Indian School of Business, Hyderabad. Welcome, sir.

Rahul Apte: Hi, Arvind. Yes, it's a pleasure to be here and thank you for the opportunity.

Aravind Ravindran: To begin with, could you walk us through your journey, sir? What first drew you towards finance and eventually led you into the world of private credit?

Rahul Apte: So essentially, finance, in many ways, if I look at my career the last decade and a half that I have spent in this segment, it started off as a choice by elimination for me. In the early parts of my career, I also dabbled in other functions like manufacturing operations and engineering, considering my basic background as an engineer from IIT Madras. But then I eventually felt that the inherent clarity and certainty that is vested in any financial analysis and financial decision-making is basically what drew me towards finance.

And especially when it comes to investing, what I also find very interesting is that it allows you to study behaviors as well, and this applies equally to economies, companies, as well as individuals, which is another facet of financing or investing that I have always found very attractive.

When it comes to my involvement in private credit, I believe, at least for lower-rated bonds in India, private credit is the way to go forward. So between this broader macro trend that we see developing every passing year and my pedigree as a dyed-in-the-wool corporate banker, I think my entry into private credit was a foregone conclusion. So here I am.

Aravind Ravindran: Thank you for sharing that, sir. It's always fascinating to hear how passion and opportunity intersect in a career. Now I would like to get your perspective on the broader market, sir. India's private credit space has seen remarkable growth recently. From your perspective, what key factors have driven this growth and where do you see it heading?

Rahul Apte: So essentially, if you see, from a regulatory standpoint, we are talking about two important regulators who essentially regulate and moderate lending and borrowing in India, essentially and respectively, the RBI as well as SEBI. Historically, the RBI, in an effort to protect the interest of small depositors, has not allowed banks to fund certain end users. How these end users have been getting funded is through counters like NBFCs or mutual funds. But then again, given the sheer size of these balance sheets and with a view to protect the interests of small retail investors, a certain degree of regulatory constraint has been imposed on traditional non-bank lenders like NBFCs and MFs.

My belief is that these regulatory constraints are here to stay and may actually get tighter. At the same time, to the credit of the regulators, they also realize that ultimately the wheels of credit in India have to remain greased, and I'm referring to corporate credit here, if India as an economy has to take off and if gross capital formation has to continue unabated. So with that view in mind, I think there has been a very careful and concerted and coordinated effort over the last 10-odd years to develop a private credit ecosystem so that you can meet both ends of the equation. You can protect small retail investors by allowing them to invest in more relatively tightly regulated entities like NBFCs and MFs, and at the same time, for the more discerning investors, for risk-seeking investors or risk-neutral investors, there is also an avenue open whereby they can participate in higher-yielding forms of lending through private credit.

So these are some of the factors which have led to the rapid development of the private credit market in India. But still, contrary to certain agencies which tend to put out very aggressive estimates on how large this market can potentially become, say over the next 5 to 10 years, I tend to be more cautious. It can be said that I'm perhaps cautiously optimistic. Directionally, I feel that this market is definitely going to grow. So it's headed in the right direction. But I also believe that this growth is more linear than exponential because, ultimately, if you look at private credit as a substitute for growth capital, fundamentally it'll be linked to things like private capex happening in India or not, which in turn is linked to the economic prospects of the economy and how the demand situation is evolving. So it will basically wax and wane with those macro variables. If you look at private credit as a solution for capital or shareholding consolidation, again it'll have a correlation to the broader private or public equity markets with all of their attendant local and global uncertainty and cyclicality.

Aravind Ravindran: Those are insightful points, sir, and it's clear the private credit market is evolving rapidly. Now, shifting gears a bit from market trends, I would like to understand the person behind the profession, sir. So outside the world of finance and deals, what keeps you motivated or inspired? Any hobbies, passions, or practices you turn to for balance?

Rahul Apte: I am an avid reader. Primarily, my interests are centered on, naturally, macroeconomics, geopolitics, history, and classic literature. And I think I'm also a fairly regular long-distance runner. So these two pursuits or hobbies, they lend a semblance of balance to an otherwise busy life.

Aravind Ravindran: That's wonderful, sir. Now I am curious to know about your investment philosophy. Looking back at your 16-plus years in wholesale debt and credit, tell us the one mistake or challenge that shaped your investment philosophy the most.

Rahul Apte: So, I've had a few learnings along the way, and I think interestingly, again, like I mentioned early on, almost all of these learnings are more on the behavioral aspects of lending and borrowing. Typically, when you tend to work on a deal or when you are engaged with a set of promoters or an issuer group and you have invested a lot of time, effort, resources, money, and bandwidth into stitching up a deal, sometimes you also see that you tend to sort of get married to the deal over a course of time. It's possible that the more time you spend, it's possible that you could lose your sense of objectivity. Interestingly, some people say that you know we got pregnant with a particular deal, so that's a very colloquial way of putting things across.

One of my key learnings is that one can never really get married to a deal and has to remain objective throughout a deal life cycle. This is one of the fundamental pillars of investing, particularly when it comes to fixed income investing in India. And one has to have the courage to act without fear or favor in case one thinks that the deal metrics or the fundamental assumptions have started to change, whether it is before the investment is made or even during the tenure of the investment.

The second is a more personal realization of the old banking maxim of promoters or borrowers exhibiting both the ability to pay as well as the willingness to pay. Business prospects and promoter acumen, these factors are important, but what is also equally important is the character of the counterparty or the person that you have chosen to invest with. I think we are under no illusion here at Nippon that no amount of fancy structuring in a deal can basically prevent these inherent risks if the character or the conduct of the promoter is doubtful.

The third learning is basically a corollary to the second learning, which basically is to say that even though an individual as a businessman or a promoter may have had a spotless track record up till this point, what I have seen is that the individual's behavior also tends to change under stress. Right? So if your initial assessment is that here is a business which could possibly experience stress or teeter over during the tenure of your investment, then you can probably not count upon the behavior of the individual behind the business to remain the same. Hence, a fundamental analysis of business prospects, of the strength of that balance sheet, the company's positioning in a sector, the viability of its products and services, is also very important so that you don't tempt fate once you have entered the trade.

Aravind Ravindran: I think our audience will find it incredibly valuable, sir, to see how seasoned professionals like you continuously learn and evolve. Now, coming to your product, Nippon India Credit Opportunities Scheme One is positioned as a pathway to risk-adjusted returns in a volatile world. Could you explain how the strategy balances risk and reward differently from traditional fixed income options? And I'm also curious to know about the scheme's focus on well-researched securities of issuers with growth. So tell us how this approach helps generate extra yield while controlling incremental credit risk.

Rahul Apte: So basically, if you look at traditional fixed income options today, let's say for example if we were to take a fixed deposit with one of these large scheduled commercial banks, investors either get hobbled by a total risk-off approach. I mean, there is no dearth of investors or fixed income depositors in India today who will still say that I will only park my surpluses in a fixed deposit of a large commercial bank, be it a public sector bank or a private bank. Such investors probably need to be reminded that not taking any risk is also a risk in itself.

On the other hand, you have investors who have a slightly greater risk appetite, but let's say if they want to dabble in fixed income options that are made available to them at, let's say, a mutual fund, again the returns tend to get moderated because of the sheer amount of constraints that are imposed on some of these schemes. In such a scenario, a risk-seeking investor or a risk-neutral investor who is looking to make at least a high single-digit return on their investment, and especially in a backdrop where the indexation benefits have been taken off a couple of years ago now by the Government of India, I think private credit remains the only viable option.

So in a setting like this, a performing credit fund such as ours, which exploits the regulatory arbitrage that it is permitted to operate with by the regulators and is mostly investing in cash flow-oriented, secured deals originated with generally investment-grade groups, it becomes a very viable investment avenue. And that's essentially how we say that we're able to generate that alpha for our investors by not building in a proportionate amount of risk. So the relative risk-reward equation gets sweetened to a certain extent.

Aravind Ravindran: Thank you for breaking that down, sir; that makes a lot of sense. A thoughtful selection process really seems key to balancing yield and risk. Now, speaking of yield, NICO is positioned in the structured credit space between BB and BBB rating, offering yields in the 12 to 16% range. What makes this segment particularly attractive and how do you ensure disciplined risk management while operating in this middle zone of the credit spectrum, sir?

Rahul Apte: I think the sheer durability and viability of this segment, and when I'm talking about this segment I'm basically talking about the segment of borrowers or issuers who typically tend to borrow at these rates, itself is a very big factor that investors should keep in mind. Now, let's say vis-à-vis compared to certain other higher-risk segments, for example, a category like venture debt with its own volatility based on what is happening in the startup ecosystem in India, or a category like special situations which took off very meaningfully in the immediate aftermath of the promulgation of IBC but then again has had its own cycle of evolution over the last 9 years, compared to some of these relatively high-risk categories, I think private credit in the 12 to 16% segment, typically known as performing credit, is expected to be more long-lasting and durable.

Fundamentally, because it presents a reasonable balance between risk and reward. From a demand perspective, and I'm talking about the demand for this product as far as the borrowers or issuers are concerned, this segment happens to be the first port of call for issuers who are, for some reason, unable to borrow from an NBFC or a mutual fund, either because of rating constraints or because of certain other regulatory constraints that do not allow NBFCs to lend to these issuers. So whether it is regulatory inflexibility or the inability of these counters to underwrite complex risk, these issuers are necessarily coming to this particular segment to borrow, which is the 12 to 16% performing credit segment. And while interest rates of 12 to 16% in the long term are not optimal, they are still deemed to be sustainable by these issuers as an acceptable cost for availing solution capital.

So this is where the entire sustainability argument comes in, that this is a segment which has historically existed in India and is now even expanding further. As far as risk management is concerned, our proprietary credit framework, which basically focuses on promoter vintage, track record, pedigree, tight deal structuring, and regular post-deal monitoring, has basically helped us manage the risks in our portfolio. As a result, our portfolio has remained regular and performing since inception.

Aravind Ravindran: Interesting. Sir, looking at the bigger picture, one of the highlights of your fund is how it fits within an overall asset allocation basket. In your view, where does private credit sit within a holistic portfolio and what kind of investors should consider it?

Rahul Apte: Like I had mentioned a couple of minutes ago, today any fixed income investor who is looking to generate a high single-digit post-tax return has to necessarily look at private credit as a solution, and more so performing credit, because like I said, it happens to be the first port of call where the risk-reward equation is reasonably balanced.

What we have also seen on the traditional options is that with a 100 basis points repo rate cut that has happened in the last 12 months, we believe that for investors who tend to dabble in either fixed deposits or who are used to trading in government-backed securities, the play for duration is also now limited. So going forward, if one were to develop a view over the next 12 to 18 months, we believe that carry is the way forward if one has to generate meaningful returns in the fixed income segment. So any investors who are looking to enhance returns within their fixed income allocation should definitely consider this as a product.

We also feel that private credit as a product, with its attendant illiquidity, is a more suitable wealth generation tool rather than a liquidity management tool.

Aravind Ravindran: It's very enlightening, sir. It helps investors understand not just returns but also the role private credit can play in holistic portfolio construction. So one aspect that stands out about the scheme is its access to mid-market and diversified businesses. What excites you most about lending to this segment and what kind of opportunities do you see here that are often overlooked?

Rahul Apte: When we scan India's corporate borrowing market in general, our own internal analysis tells us that there are thousands of mid-market companies in India today which are very well entrenched in their respective sectors. These companies have not been able to scale either because the promoters have been too conservative with respect to debt-fueled growth or have been unwilling to cede control by inviting external equity participation in their balance sheets.

But what should be seen is that the level of engagement in these companies, as far as the promoter family or the family driving the business is concerned, is very high. The level of promoter interest and alignment is very significant. Many of these businesses actually tend to be generational calls, with either the son trying to preserve and grow the legacy of his father or the father trying to create something of meaning and significance for their son.

So when these companies essentially have to hit the private credit market for certain non-bank end uses that other traditional lenders cannot provide for, we think that their limited scale should not become the sole basis on which these companies should be turned down as a potential investment opportunity. Also, because these companies are smaller, what we have seen is that they are more amenable to tighter structuring. Their promoters are more receptive to prudent advice. They may offer better terms and pricing to private credit investors, and there is, in general, a lesser degree of variables or variability that investors have to worry about in relatively smaller balance sheets.

So it is because of these reasons that, within our proprietary credit framework, we remain very open to exploring opportunities in mid-cap corporates.

Aravind Ravindran: It's clear how schemes like NICO create meaningful value for investors. Now, coming to your focus, I'm curious about the broader framework where Nippon prefers core exposure in balance sheet funding and structured debt while consciously avoiding stressed assets and venture debt. What drives this distinction and how do you capture attractive risk-adjusted returns without drifting into riskier segments which you have chosen to avoid?

Rahul Apte: I think the most important trick basically lies in deal sourcing. Thanks to our pedigree as a major asset management company in India—we are the largest non-bank-backed asset management company in India today—our sourcing funnel is very wide. So between the in-house sourcing that we do as fund managers and the deals sourced by intermediaries, our partner banks, NBFCs, etc., almost every deal of substance is shown to us.

Just to give you an example, in our first fund today, we have made about 16 investments over the last two-odd years. And to make these 16 investments, we have had to choose from a total deal universe of close to 200-odd deals. So that's the degree of filtering that we are able to do, which also says that 200-odd deals have been actually run by us. This allows us to be picky and allows us to cherry-pick deals which basically fit our credit philosophy.

The other significant factor I believe is that we have been able to right-size our fund. We believe that right-sizing of a credit fund is very important to prevent adverse credit selection. If you're running a very small fund, you are not a player of significance in the market. You will not be the first port of call for some of the best deals that are available at any juncture, and also your exposure will be small. So your significance at the cap table of the borrower will be curtailed, and hence your ability to influence the borrower in case the situation or the initial assumptions change will also be limited.

At the same time, if you have ended up raising a lot of money and you're running a very large fund, let's say something in excess of 2,000 crores, you yourself could come under deployment pressure, in which case you may be forced to sort of dilute some of your own parameters. So with a fund size of close to 1200 crores that we have managed in our first fund, I think we are optimally placed. We have been able to right-size our fund, and it is a combination of our pedigree as a major AMC and the right-sizing of our fund that has actually allowed us to be picky and choosy about the deals that we have done.

Aravind Ravindran: That distinction really highlights how discipline and focus on quality exposure can help deliver strong risk-adjusted returns, sir. So, speaking of disciplined approaches, I would like to understand your deal structuring philosophy. Your deal structuring approach emphasizes multiple layers of security. In practice, how do you strike the right balance between stringent structuring to protect the downside and allowing operational flexibility for the promoters to grow and service their debt?

Rahul Apte: See, ultimately, I think the fundamental premise is very simple: the balance sheet of an investee must grow and must get better to protect the interests of a wide variety of stakeholders, be it debt investors or equity holders. So allowing sufficient operational and financial headroom for the promoter to actually meaningfully undertake a growth journey is very important, and we realize that.

That said, at the same time, because of our presence as an AMC and because of a very wide funnel that we tend to have at our end, we are able to assess the growth prospects of a company by comparing it to similar journeys that other peers in the same segment or sector may be undertaking at the same juncture or may have undertaken in the past. So basically, what I'm trying to say is that we have our own in-house view about what levels of growth could be feasible, given the particular state or the particular financial flexibility available to a borrower group. And especially in cases where the growth journey is going to be undertaken using debt, we tend to have our own views.

So this is where the checks and balances aspects come in. While of course we are sensitive to the fact that growth is the primary objective, the degree of feasibility is where we tend to have our own specific views, and generally then we tend to limit it, especially in terms of leverage, if this growth is going to be debt-funded.

Aravind Ravindran: Fantastic, sir. It really illustrates how rigorous structuring and careful execution translate into tangible results. On a broader note, I would like to explore your portfolio construction process, sir. With NICO's sector-agnostic strategy, 8 to 12 securities, and an average tenure of up to 3 years, how do you decide the sector mix, balance tenures, and ensure diversification?

Rahul Apte: So, we are a sector-agnostic performing credit fund, and I derive a great deal of satisfaction to report that over the last 24 months we have worked extremely hard to also practice what we have been preaching all along. We are fairly sensitive and fairly concerned about concentration risks when it comes to both sectors as well as companies, and we think that fundamentally, when it comes to concentration of risk, it has to be a very patient and deliberate choice that the fund manager or the investment manager can make.

Again, this is also where having a very wide funnel allows us the leeway to pass up deals and keep the portfolio healthy and diversified, which is what we have managed to do over the last 24-odd months. When it comes to exposure to certain sectors, we generally have a threshold of 20%, which is something that we do not like to cross. I am very happy to report that when it comes to the actual fund characteristics today, we are well under the 15% mark when it comes to even sectoral exposure.

The tenure equation in a fundamental performing credit fund with a whole life of five-and-a-half to six years is rather simple. You tend to keep your average maturity around the three to three-and-a-half-year mark, and you generally tend to reserve the last one-and-a-half to two years for managing exits and winding down your exposures.

Aravind Ravindran: That provides a clear picture, sir. Now, looking from an investor lens, could you explain the fund's liquidity profile, sir? What restrictions apply to redemptions during the fund's tenure? Also, tell us for new investors coming today, what is the expected drawdown schedule?

Rahul Apte: Essentially, if you look at the evolution of this whole category, and by category I mean Category 2 AIFs, one of the fundamental misalignments or problems that the regulator identified very early on was that you cannot essentially run an open-ended scheme when the investments of that scheme are sort of close-ended or illiquid in nature. Because therein you build in a fundamental asset-liability mismatch. If a fund essentially borrows money from an investor with a three to three-and-a-half-year view and if that same fund ends up making that loan to somebody for four years, essentially you are trying to lock in both ends of the equation. During the tenure of this fund, if the investor were to approach the fund and say that I want interim liquidity or I want to pull out my investment, the fund is probably unlikely to liquidate because the end use of this money has gone towards a long-term capital formation or a long-term end use wherein the promoter needs a certain bit of time to turn a balance sheet around meaningfully, generate returns, and then give the principal as well as the interest back to the fund. So which is why, by design today, Category 2 AIFs exist as close-ended schemes.

That said, because we have such a sharp focus on cash flow generating opportunities, we tend to invest in companies which pay us regular interest at either monthly or quarterly frequency, and hence we have been able to make monthly distributions to our investors right since the inception of this fund. The first fund is largely drawn down, and we hope to achieve full deployment in this financial year. So that's a little bit about the liquidity characteristics with which we have operated.

Aravind Ravindran: That really clarifies how liquidity is managed. Sir, shifting focus to the future, are there any new private credit funds in the pipeline from Nippon India Alternative Investments? What stage are they at and when can we expect the launch?

Rahul Apte: Yes. So we expect to launch our second fund in the second half of this fiscal year. I think Q3 FY26, subject to certain other prerequisites getting met, the larger market will hear from Nippon about our second offering. The second offering will also be within the performing credit segment itself, and the fund construct is expected to be very similar to the first fund which is already in existence.

Aravind Ravindran: Sounds good, sir. Looking forward, which themes or sectors within private credit do you see as most promising over the next 3 to 5 years in India?

Rahul Apte: At Nippon, we have consciously chosen to stay away from, let's say, a sector like residential real estate, the typical construction finance that a lot of tier-1, tier-2 builders avail from private credit funds. This we are not passing a value judgment; it's just that Nippon Alternatives has other solutions available for such needs.

So, casting residential real estate aside, we think that broadly speaking, any sectors or sub-sectors which are directly or indirectly involved in gross capital formation in a country like India, which is much underserved and under-capacitated—let's say for example infrastructure and allied sectors in general—are expected to remain relevant. That said, sector assessment is a very dynamic and ongoing activity that we actually undertake every quarter at our end, because we have to constantly assess the sector dynamics that unfold across different sectors. We also tend to believe that it could be a bit imprudent to take too long a view in too many sectors.

Aravind Ravindran: Understood, sir. Next, we will move to a quick round of rapid-fire questions. For each question, you can just pick the one that resonates with your views.

Rahul Apte: Sure.

Aravind Ravindran: In the current market, which looks more attractive for private credit: mid-market corporates or large established businesses?

Rahul Apte: Current market, and in general, mid corporates.

Aravind Ravindran: Super. When structuring a deal, what's more critical to you: credit rating and financial metrics, or promoter strength and governance quality?

Rahul Apte: I would say promoter strength and governance quality.

Aravind Ravindran: Wonderful. For investors, what's the bigger appeal of private credit, sir: superior risk-adjusted returns, or regular and predictable cash flows?

Rahul Apte: I would go with superior risk-adjusted returns. There are all categories of investors; some are not so bothered with regular cash flows.

Aravind Ravindran: Got it. Which sector offers better private credit opportunities right now, sir: infrastructure and renewables, or consumer and services?

Rahul Apte: I would go with infrastructure and renewables.

Aravind Ravindran: In a volatile environment, what's the greatest challenge: managing credit risk, or finding a quality deal flow?

Rahul Apte: Managing credit risk.

Aravind Ravindran: Wonderful, sir. So that brings us to the end of today's session. Thank you, sir, for your time and sharing such thoughtful perspectives. It's been a pleasure having you with us.

Rahul Apte: Thank you very much, Arvin. It was a pleasure talking to you, and I hope to continue our interactions in the future as well.

Aravind Ravindran: Thank you, sir. And to our viewers, we look forward to bringing you more such meaningful conversations with industry leaders here at PMS Bazar. Until we meet again, take care and goodbye.