ET Capital Markets SummitET Edge
Panel Discussion: Aligning with Opportunities: Where to invest? What percentage to invest? In which sectors to invest?
Upcoming Alternate Investments Fund options in India and how do you create awareness on investment opportunities? The necessity to look at development of Long Term hedging market in India through Alternative Investment Funds.
- Indian Capital Market and Investors are maturing. Investors have remained calm and patient despite the turbulence.
- Investors are looking at very specific strategies
- Going forward, AIFs to become important for HNIs and FIIs
- Investors need to understand and be aware of the differences in risks associated with AIFs as opposed to Mutual Funds.
Will AIFs and Mutual Funds co-exist?
- Both are investment platforms, key factor being the strategy implemented on each platform. Volatility is also an important factor.
- In equity one can target 14-16% returns but run the risk of losing 25-30%, hence one cannot put in a large pool of capital.
- With Mutual Funds, SIPs reduced the risk
- AIFs aim to achieve moderate returns with lower risk
- Gaps still present in the Indian Market. Global investors are presented with more investment options as opposed to Indian Investors.
- Capital is available, identifying the right opportunities is key
When would the first REIT be reality? What are the challenges?
- While REITs have been in discussion for over a decade, we expect it this year with the first DRHP towards the end of April/May 2018.
- Regulatory and Tax impediments accounted for the delay
- Leaving aside inherent issues with RE, skepticism still surrounds REITs
- REIT is a hybrid instrument, i.e. an equity investment with debt-like returns
- Challenge is for REIT operators to transfer capital from SPV to SPV
- Provides an opportunity for small investors, removing asset management risks
- Investors generally focus on returns, equally important to focus on associated risks. Key is to diversify. Expecting exciting times ahead.
FPIs worldwide believe that India is an attractive investment destination among emerging markets. Buoyed by relatively positive growth rates, India continues to be an attractive investment destination, specifically among emerging markets. Programmes like Make in India, Skill India, Digital India, Smart Cities, as well as the JAM trinity (Jan Dhan Yojana for financial inclusion, Aadhaar for Direct Benefit Transfer and use of mobile technology for the delivery of last-mile services), have been launched by the Indian government to promote all-round growth.
India ranks 100 in the World Bank Report of Doing Business in India 2017. The government has expressed its continued commitment to improving India’s world ranking. Tax has emerged as an important area of reform, with the last Indian Budget laid out in the Parliament including it as one of the nine distinct pillars of transformation. The government has provided impetus to put in place a long-term, stable, predictable and non-adversarial tax regime, one outcome of which would be an improvement in the above ranking. The results of this survey indicate that the needle on tax appears to be moving in the right direction.
2015-16) has been 17%.many countries, debt market (both sovereign and corporate) is larger than equity markets. In fact, in matured economies, the debt market is three times the size of the equity market. However, in India like in emerging economies, the equity market has been more active, developed and has been the centre of attention be it in media or otherwise.
The optimism towards investing in India is evident from portfolio investments in debt and equity in the country. Though there has been a slowdown in the last years, the CAGR of cumulative investment inflows into India in the last decade (2006-07 to 2015-16) has been 17%.
In many countries, debt market (both sovereign and corporate) is larger than equity markets. In fact, in matured economies, the debt market is three times the size of the equity market. However, in India like in emerging economies, the equity market has been more active, developed and has been the centre of attention be it in media or otherwise.
Nevertheless, the Indian debt market has transformed itself into a much more vibrant trading field for debt instruments from the elementary market about a decade ago. Further, the corporate debt market in developed economies like US is almost 20% of their total debt market. In contrast, the corporate bond market (i.e. private corporate sector raising debt through public issuance in capital market), is only an insignificant part of the Indian debt market.
Amongst the most important reforms is the development and deepening of the non-public debt capital market (DCM), where growth has been lack lustre in contrast to a soaring equity market. The stock of listed non-public-sector debt in India is currently estimated at about USD 21 billion, or about 2% of GDP, just a fraction of the public-sector debt outstanding (around 35% of GDP), or the equity market capitalisation (now close to 100% of GDP). To strengthen the Indian financial systems it is now pertinent to develop the environment for corporate debt market in India.
The limitations of public finances as well as the systemic risk awareness of the banking systems in developing countries have led to a growing interest in developing bond markets. It is believed that well run and liquid corporate bond markets can play a critical role in supporting economic development in developing countries, both at the macroeconomic and microeconomic levels. Though the corporate debt market in India has been in existence since the Independence in 1947, it was only after 1985-86, following some debt market reforms that the state owned public enterprises (PSUs) began issuing PSU bonds. However, in the absence of a well functioning secondary market, such debt instruments remained highly illiquid and unpopular among the investing population at large.
Recent developments in the corporate debt market in India
In the recent past, the corporate debt market has seen a high growth of innovative asset-backed securities. The servicing of debt and related obligations for such instruments is backed by some sort of financial assets and/or credit support from a third party. Over the years greater innovation has been witnessed in the corporate bond issuances, like floating rate instruments, zero coupon bonds, convertible bonds, callable (put-able) bonds and step-redemption bonds.
These innovative issues have provided a gamut of securities that caters to a wider segment of investors in terms of maintaining a desirable risk-return balance. Over the last five years, corporate issuers have shown a distinct preference for private placements over public issues. This has further cramped the liquidity in the market. The dominance of private placement in total issuances is attributable to a number of factors.
- Lengthy issuance procedure for public issues, in particular, the information disclosure requirements
- Costs of a public issue are considerably higher than those for a private placement
- The quantum of money raised through private placements is typically larger than those that can be garnered through a public issue. Also, a corporate can expect to raise debt from the market at finer rates than the prime-lending rate of banks and financial institutions only with an AAA rated paper. This limits the number of entities that would find it profitable to enter the market directly.
The economic advantages of having a viable private DCM can be grouped into three broad categories.
It gives providers of capital access to a broader set of diversification opportunities. In India today, household wealth is parked in bank deposits, real estate and gold, with very limited stock ownership. More active insurance and pension markets, for example, would allow families to spread investment risks more broadly. In turn, these institutional investors would contribute to enhancing credit price disclosure as they allocate resources into interest-bearing securities. Efficiency in managing cost of capital: Access to a functioning DCM, and the multiple financing options that come with it, endows borrowers with greater efficiency in managing the cost of capital. Historical and cross-sectional experience teaches that problems in the banking sector can interrupt the flow of funds from savers to investors for a dangerously long period of time. Indeed, one of the lessons from the 1997 Asian financial crisis has been the importance of having non-bank funding channels open. In the wake of this crisis, a number of countries in the region, including Korea, Malaysia, Singapore and Hong Kong, have made progress in building their own corporate debt markets.
On-the-ground estimates indicate that the total stock of non-equity claims on India’s corporate sector could be somewhere in the region of 10% of GDP. With listed securities worth just USD 21 billion, this means that roughly 80% of the market is in the form of private placements. These liabilities are negotiated and priced on the principles of relationship lending, issued with virtually no public disclosure, and are typically held to maturity by banks. This brings us to a third set of reasons why developing a debt capital market is in India’s interest. The current system of financing has already, and will increasingly, become less adequate for an economy as large and as ambitious as India’s. Spreading credit risk from banks balance sheets more broadly through the financial system would lower the risks to financial stability. And a deeper, more responsive interest rate market would allow the central bank greater degrees of freedom in the conduct of monetary policy. This will be particularly important as India gradually opens up its capital markets to the rest of the world.
Indeed, one of the lessons from the 1997 Asian financial crisis has been the importance of having non-bank funding channels open. One of the causes of the Asian financial crisis was over-dependence of the Asian corporations on short-term foreign funds and mismatch of currencies. Before the crisis, Asian banks were dependent on shortterm foreign currency funds (similar to external commercial borrowings in India) and corporations were dependent on short-term funds from such banks. Such dependence on short-term foreign currency funds was the reason for the rapid outflow of capital from Asian countries as soon as confidence in these countries started to fade. If bond markets had been more developed in Asia and if domestic bond markets denominated in their own currencies, had worked efficiently, the impact of the crisis would have been softened or entirely prevented. The development of local currency bond markets has been seen as a way to avoid crisis, with these markets helping to reduce potential currency and maturity mismatches in the financial system. The Tarapore Committee also recommends the development of an active debt market as a prerequisite for capital account convertibility.
Apart from its fundamental role of achieving allocative efficiency, a well-developed government bond market strengthens the monetary policy implementation framework by equipping a central bank with market-based indirect instruments. Further, a vibrant corporate debt market would allow corporates to get a standardised rate and fees instead of individually negotiating these with a syndicate of banks for loan finance. But corporates don’t have a choice of issuing significant amount of bonds in India. Sooner than later, banks may find that their entire appetite for lending is soaked up by top tier corporates.
Transformation is a result of embracing change. RE sector was facing innumerable issues when government started reforms in FY 16. To revive the sector, the Government has adapted to the internationally accepted standards, encouraged innovation in technology, introduced reforms in the existing policies and took some bold steps like introduction of RERA & GST and the Benami Act to curb the use of black money. The real estate space in India is making a strong comeback and consumers are shifting from a negative to a positive outlook, which is the icing on the cake.
Real estate market in India stands at USD 145 bn and is dominated by the residential segment which accounts for 82% of market
 Market sizing indicates annual transactional value Source: Knight Frank Reports, CRISIL, JLL, IBEF, Trade Publications, PwC Analysis
A few years ago, foreign investors were shying away from the Indian real estate sector due to uncertainty in yields and tenure of lock-in for investments coupled with a lack of transparency. The enactment of The Real Estate Regulatory Act in 2016 was India’s biggest and most awaited regulatory reforms with a far-reaching impact on the real estate sector. RERA has ensured increased transparency trust and accountability, has brought best practices into the sector and most importantly, has addressed the issue of grievance resolution. RERA seeks to protect the interests of homebuyers as well as instill confidence in institutional investors to invest in this sector.
Large funds such as Brookfield Asset Management, Blackstone Group, CPPIB, Goldman Sachs, Qatar Investment Authority and GIC, have made numerous investments in the Indian real estate assets over the last few years. Additionally, investors are drawing comfort from the recent regulatory reforms and more funds are eyeing this sector and looking for investment and alliance opportunities.
Firstly, increased transparency and disclosures under RERA will facilitate efficient due diligence and higher partner and sector confidence will boost equity participation. Right projects and developers in the annuity income generating space, like office and warehousing, will surely attract equity investments. Secondly, construction funding rates are higher than mortgage rates; putting pressure on developers. Awarding infrastructure status to the sector can help lower the gap and aid debt-laden developers.
Recently introduced regulations are expected to provide a fillip to the Indian real estate market:
Despite enduring cynicism that India’s suffocating bureaucracy would effectively snuff out the chances of any early introduction of the country’s first REITs, there now seems a real prospect that India’s maiden REIT will be listed by the end of the first quarter of 2018.
REITs in India, will open the gates to access public markets and will be a medium for the Private Equity Funds to make a profitable exit. The Real Estate sector will now graduate from being an ‘illiquid’ sector to having enhanced liquidity as REIT gains success and popularity.
Foreign investors have been very keen to invest in India and have actively picked up marquee assets yielding desired returns in the commercial space. Continued interest and willingness of the investors to invest in India propelled the Govt to put in place favourable policies and create a suitable environment for REITs to become an economically viable option for all the parties at stake.
Tried & Tested Model
- Globally, the USA and Singapore markets have their biggest REITs in the commercial and retail asset classes. Typically, conventional asset classes form the first movers of REIT markets
- Now that there is no regulatory logjam and introduction of GST, most tax related concerns have been resolved. We expect the Prime office portfolios in India to be the first ones to list a REIT.
- The RE sector will now see consolidation through M&A activity in the next few years where the larger portfolios will acquire smaller players in order to diversify their investment.
India – Status Quo
- According to ET, the Indian real estate is likely to provide investment opportunity worth up to $77 billion through REIT-eligible commercial office and retail, properties across the country’s top seven cities by 2020.
- REITs are likely to debut in the commercial space considering fixed income nature of the assets. PE players have built up a good portfolio of assets with attractive valuations over the last 5-6 years. Although there are no REIT listings yet, many PE players are giving it a serious thought and are deliberating on exploring the same.
Food for thought:
- Current budget, which has announced the Long Term Capital Gains Tax, will hamper the real returns for investors. Additionally, 30% tax rate for domestic investors will also result in subdued participation.
- Another issue that needs to be addressed by the Govt is the stamp duty rate. The rates are very high in some states. This inconsistency might eat up the value created for REITs.
- Reports estimate that India’s RE market will cross US$ 180bn by 2020, fueled by factors like growing population, rising incomes and lifestyle upgradation by the middle class, increased digital connectivity and advancement in technology.
- Investors have now shifted their focus to Tier 2 & 3 cities due to better growth prospects in retail space. Due to lack of good quality retail mall assets, spanning across emerging cities, investors have adopted both green-field and brown-field to build projects.
- Although the residential sector had a major setback in the last few years, increased transparency, better reforms and investor friendly environment have set the path to recovery. Office segment continues to attract investors owing to reducing yields and good asset portfolios.
- Smart city mission coupled with affordable housing are important themes for the sector and popular amongst the investor community.
- There is a huge untapped potential for alternative assets in India. Institutional funds are keen to expand their footprint beyond conventional asset classes. They contemplating on creating a long-term strategy to invest in assets such as student housing, senior living, healthcare, warehousing and logistics and hospitality industry, which is seeing a gradual revival in the recent days.
- The first REIT is expected to be launched by the Embassy-Blackstone partnership. Embassy Group is a commercial real estate developer and is the Indian partner of Blackstone Group LP. They are laying the groundwork for the nation’s first real estate investment trust, which aims to open a market that has attracted many investments globally. They plan to issue the bond-like securities and a draft prospectus is expected to be filed by June with the listing to follow a few months after.