Should investors in India be building an ARC?

International players pouring money into Indian credit opportunities have an intriguing choice between distressed and performing strategies.  

This week the Canada Pension Plan Investment Board (CPPIB), so often in the vanguard of new strategies, revealed a joint venture to invest in non-performing Indian credit.

CPPIB is putting up $450 million for a $525 million distressed asset investment vehicle with the Kotak Mahindra Group, the financial services firm led by Indian billionaire Uday Kotak. It will invest into stressed assets alongside Kotak’s asset reconstruction company (ARC), Phoenix ARC, which has been buying bad assets from local banks for more than a decade.

Similar initiatives are underway elsewhere. US private investment firm JC Flowers & Co is teaming up with Ambit, an investment bank, while the Piramal Group, one of India’s largest investment companies, has said it will raise close to $900 million by listing a new investment vehicle focused on distressed assets.

India’s banking sector is sitting on an estimated $40 billion of bad assets and partnering with an ARC can provide international investors with a route to that opportunity. The vehicles were intended by the government to help banks offload their woes and have gathered $6 billion in assets in the past two years alone, according to Ambit.

So if lots of bad assets troubling their current owners and a government keen for incomers to clear them out of the system sounds like an open and shut case for investment then that’s because it probably is.

However, it is also worth noting that the case for non-bank direct lending to mid-sized Indian businesses is even more compelling.

The state controls most of the banking sector and requires it to lend to high priority areas such as infrastructure. Another large chunk of banks’ balance sheets goes into government debt, and most of the rest tends to flow to the largest of the country's corporates. India has 3,000 listed businesses and 90 percent of listed corporate debt is owed by only 10 percent of those firms, according to Goldman Sachs.

As a result, the country’s mid-market, mainly family-owned businesses, are finding credit difficult to come by. This makes for a huge market and investment firms have only scratched its surface.

It’s not without risk, of course, as the many burnt private equity investors in India will tell you. The difference is that, for now at least, Indian borrowers looking for funding have little option but to turn to alternative lenders. Foreign private debt providers are likely to be welcomed with open arms.

So with both distressed and performing credit representing viable investment avenues into the country, India-minded investors are invited take their pick. If you’ve got the money and the appetite, it’s feasible to follow CPPIB and do both. Before it decided to go into distressed with Kotak, the Canadians partnered with Piramal for a real estate mezzanine strategy.

If you don’t have that luxury, there’s a choice to be made. And it’s worth making as long as you have the risk appetite. Choosing not to invest into India at all might prove short-sighted.