Funds for distressed assets are category II Alternative Investment Funds (AIFs), which invest in stressed assets of various companies, with the investment philosophy that not all NPAs are bad assets and a turnaround in these will provide a good return.
The key to success of a distressed asset fund lies in buying good underlying assets at reasonable valuations, which have potential for a turnaround.
Why invest in distressed funds?
Distressed investments have low correlation with equity or debt markets. Hence, the asset class can provide diversification for investors.
Who invests?
Distressed asset funds usually raise commitments from big institutional players such as banks, large pension funds and insurers, which include global entities.
According to SEBI regulations, the minimum ticket size for an investor of distressed asset funds is Rs.1 crore and the number of investors in any scheme cannot be more than 1,000.
Investment conditions
Given that distressed asset funds fall under category II AIF, they primarily invest in unlisted companies or in units of other AIFs.
Distressed asset funds cannot take leverage frequently. However, they can borrow funds for meeting temporary requirements only for 30 days and only on four occasions a year, not more. The borrowed amount must not be more than 10% of its investible funds.
These funds can engage in hedging.
These funds can invest in unsubscribed portion of an IPO by entering into an agreement with a merchant banker.
SEBI has exempted these funds from Insider Trading Regulations only if the fund invests in Small Medium Enterprises listed on SME exchange. However, these funds will have to hold such securities at least for a year.
These funds are close-ended with a minimum tenure of three years.
Key players in market
Edelweiss, Kotak AMC, Piramal Group and Eight Finance Private Limited are among the renowned players in distressed assets fund space.
Advantage over other financial institutions
Distressed asset funds are emerging as new source of credit for corporates, a space that has largely been occupied by banks, NBFCs and mutual funds.
Distressed asset funds are also better placed than other financial institutions to handle credit events because of their close-ended and private placement nature.
One of the biggest advantages of these funds is capital efficiency. While lending capacity of banks and NBFCs is limited due to capital adequacy norms, this is not the case with distressed asset funds.
In contrast to an NBFC, which is required to have a capital adequacy ratio of 15% and a bank, which must have 9%, a credit AIF in category II only requires the sponsor to invest Rs.5 crore or 2.5% of AUM, whichever is lower. This means that for a loan book greater than Rs.55 crore, a credit AIF requires less equity than even the most capital efficient bank.
Features:
- A high risk-high return investment
- Low liquidity
- Long investment horizon
- Diversification