What Is Private Credit? How Performing Credit Funds Work in India

When a mid-sized Indian company needs ₹150 crore to buy a competitor or build a plant, the obvious first call is a bank. Increasingly, the money comes instead from a fund that pools capital from wealthy families, insurers and pension funds and lends it directly on privately negotiated terms. That is private credit, and its core form, the fund lending straight to a company, is called direct lending.

The IMF, in its April 2024 Global Financial Stability Report, describes private credit as non-bank corporate credit provided through bilateral agreements or small "club deals", outside public bond markets and commercial banks. Three features separate it from the bonds and debt mutual funds most investors already own:

• It is negotiated, not bought off a screen. The lender and borrower agree on the amount, interest rate, repayment schedule, security and covenants one deal at a time.
• It is usually held to maturity. There is little or no secondary market, so the fund earns its return from interest and repayment, not from trading.
• It is concentrated. A typical Indian fund holds 15 to 25 loans, not hundreds of bonds.

In India, this kind of lending reaches investors mainly through Alternative Investment Funds (AIFs) regulated by SEBI. Funds that lend fall in Category II, which SEBI's AIF Regulations describe as including "debt funds" that do not use leverage beyond what the rules allow. A "credit AIF" or "structured credit fund" is almost always a Category II vehicle.

The asset class is a family of strategies, and the label on the fund matters. This guide covers performing credit, the middle of the risk spectrum.

Venture debt and special situations get their own guides; here they are only contrast. One industry panel likened performing credit to mid and small caps and venture debt to micro-caps: related, but very different risk.

Globally, the asset class took off after the 2008 financial crisis, when tighter capital rules made banks cautious about riskier mid-sized borrowers and funds stepped into the gap. India followed a decade later, for its own reasons.

India's corporate lending market went through a long clean-up. The RBI's Asset Quality Review began in FY2015-16, forcing banks to recognise bad loans and repair balance sheets. Banks' share of total commercial credit fell from a peak of about 73% in 2011 to 64% in 2022, according to research by Rajeswari Sengupta and Pratik Datta.

NBFCs filled part of that gap until the IL&FS default in September 2018 froze much of their funding, leaving mid-sized companies, too small or unrated for the bond market, with fewer options. Meanwhile the Insolvency and Bankruptcy Code, 2016 strengthened creditors' hands, making lending outside the banking system more viable.

Banks also face restrictions that funds do not. Vinod Kothari Consultants notes that banks generally cannot fund land acquisition or lend to promoters to buy shares of other companies, and estimates that real estate and acquisition financing each make up roughly a third of deals. SEBI's AIF Regulations, in force since 2012, gave this capital a regulated home in Category II.

Until May 2025, a Category II AIF had to invest "primarily in unlisted companies". That rule collided with a separate change: from 1 January 2024, under the SEBI listing regulations, any company that already has listed debt can only issue further debt in listed form. The pool of unlisted debentures available to credit funds started shrinking.

SEBI's own board paper noted that 196 Category II schemes had more than half their portfolio in unlisted debt as of 31 December 2024, and that such funds take on "both liquidity risk and Credit risk". Its answer, effective 23 May 2025, was to let Category II AIFs meet the "primarily" test with unlisted securities and/or listed debt securities rated 'A' or below. The rating ceiling keeps credit AIFs taking genuine credit risk rather than turning into high-grade bond funds.

On the investor side, the RBI tightened who can put money into these funds. The Reserve Bank of India (Investment in AIF) Directions, 2025, dated 29 July 2025 and in force from 1 January 2026, cap any single bank or NBFC at 10% of an AIF scheme and all RBI-regulated lenders together at 20%. A lender holding more than 5% of a scheme that has non-equity exposure to one of that lender's own borrowers must make a 100% provision for its share. The aim is to stop lenders "evergreening" weak loans through AIFs; SEBI's AIF Master Circular imposes matching due-diligence duties on managers.

Most of these funds target mid-market companies: established businesses that are profitable or close to it, with a track record of repaying debt. One fund launched in October 2024 defined its universe as companies with revenues between ₹250 crore and ₹5,000 crore, across MSMEs, manufacturing, services and fintech. Another, launched in May 2026, described its targets as businesses with "stable cash flows, established operations, and consistent debt repayment records".

Common uses of the money include:

• Acquisition financing, where banks face restrictions on lending to promoters to buy shares.
• Growth capex such as new capacity, a new plant or a new product line.
• Refinancing expensive or short-term borrowings into a single longer loan.
• Promoter funding secured against shares and other assets.
• Real estate construction and last-mile finance, a large slice of the Indian market.
• Lending to NBFCs, which on-lend to MSME, microfinance or vehicle-finance borrowers.

The common thread: borrowers that are bankable on cash flow but need speed, flexibility or a structure a bank cannot offer.

The workhorse instrument is the non-convertible debenture (NCD), listed or unlisted, often senior secured. Funds also use structured debentures with back-ended premiums. A typical loan is protected in several layers:

• Security cover: a charge over fixed assets, receivables, or a pledge of promoter shares, sized so the collateral value exceeds the loan.
• Cash-flow controls: escrow arrangements that capture sales receipts before they reach the borrower, sometimes with a reserve account set aside for interest.
• Covenants: maintenance tests such as maximum debt-to-EBITDA or minimum interest cover, plus restrictions on new borrowing, dividends and asset sales. Most deals carry at least one financial maintenance covenant.
• Guarantees: personal or corporate guarantees from promoters or group companies.
• Amortisation: principal repaid in instalments rather than all at maturity, which shortens the fund's risk window.

A loan can be "senior secured" on paper and still be weak if the collateral is illiquid or the covenants loose, so each deal's structure matters more than the label.

A performing credit fund in India is a closed-ended Category II vehicle, usually set up as a trust, with a sponsor, an investment manager and a trustee. SEBI's AIF Regulations set the outer limits, and the SEBI Master Circular for AIFs (updated 7 September 2026) fills in valuation and reporting detail:

You do not hand over ₹1 crore on day one. You sign a commitment, and the manager calls the money in tranches as it finds loans to make; capital calls deserve a guide of their own.

Wealth managers describe a typical cycle like this: capital drawn over roughly the first year, quarterly interest distributions beginning in year one, principal returned as loans amortise from around years two to four, and a total fund life near six years. Many funds also recycle early repayments during the investment period instead of returning them, which keeps money working but delays your capital coming back.

Consider an investor who commits ₹1 crore to a five-year fund. The figures are purely illustrative, not a projection for any real fund:

Timing matters as much as the rate: because capital comes back in pieces, your cash multiple will be lower than a five-year deposit compounding at the same headline rate.

Returns are quoted in a confusing mix of gross yields, target IRRs and net IRRs. Here is how published numbers line up:

Treat these as indications, not forecasts. More useful is breaking a headline yield into what it pays you for:

1. Base rate. What a government bond of similar maturity pays.
2. Credit spread. Compensation for the chance the borrower does not repay in full.
3. Illiquidity premium. Compensation for being unable to sell for five or more years.
4. Complexity premium. Compensation for bespoke structuring, monitoring and enforcement work.
5. Minus fees and expenses. Management fees, any performance fee above a hurdle, fund expenses and 18% GST on fees.
6. Minus credit losses. Defaults that are not fully recovered.

Fund documents make the gap visible. One fund launched in October 2024 targeted a portfolio IRR of about 13–16% but an investor net return of about 12–13%. That 1–3 percentage point difference is fees and costs before any default. If a single 10% position defaults and recovers half, the portfolio loses roughly five percentage points of value in that year, a large bite out of a 12% annual return.

A debt mutual fund or debt PMS offers liquidity and diversification across rated paper; a credit AIF offers a higher contractual yield in return for lock-in and concentrated credit risk.

On tax, Category II AIFs have statutory pass-through status (section 224 of the Income-tax Act, 2025, formerly section 115UB): interest the fund earns is taxed in your hands as if you had earned it directly, at your slab rate, and the fund deducts 10% TDS on income it credits to resident investors. Income not actually paid out is deemed credited to you at the end of the year, so you can owe tax before you receive cash. Rules for non-residents differ, and the mechanics change with each Finance Act, so take advice from a tax adviser before investing.

Used well, this strategy fills a real gap in an Indian portfolio:

• Higher contractual income. Fund managers say Indian credit AIFs typically target 14–18% net IRRs, against roughly 6–9% from traditional fixed income. Even after a haircut for optimism, the spread is meaningful.
• Regular cash distributions. Quarterly income starting in year one is common, which suits investors who want cash flow rather than only paper gains.
• Secured, covenant-protected positions. Senior security, escrowed cash flows, amortising schedules and promoter guarantees give the lender several lines of defence before a loss.
• Returns tied to cash flows, not market moods. Performance depends on borrowers repaying, not on daily equity or bond prices, which can make it a useful diversifier for equity-heavy portfolios.
• Built-in regulatory guardrails. The fund cannot use leverage to juice returns, cannot put more than 25% of investable funds into one company, must use independent valuation and must report to benchmarking agencies.
• No liquidity mismatch. A closed-ended fund matches capital to loan tenors, so no one can run for the exit mid-way.
• Professional underwriting and monitoring. A fund spreads risk across 15–25 deals and brings legal, credit and recovery teams most individual investors could not build themselves.

That last point is the core value: you earn a lender's return on mid-market risk without becoming a lender.

Estimates vary because much of the market is private. Industry estimates put Indian assets at about US$25–30 billion as of March 2025, around 0.6% of GDP, compared with roughly 3.8% in the US. Preqin data cited by one manager shows India-focused private debt assets growing from US$0.7 billion in 2010 to US$17.8 billion in 2023. Deal data quoted by a wealth manager puts 2025 deal value at US$12.4 billion, with real estate the largest sector at about 42% of activity.

SEBI's AIF data shows the size of the category these funds sit in. As of 30 June 2026, Category II AIFs had raised commitments of ₹13,02,837 crore, with ₹4,78,195 crore of funds actually raised and ₹4,28,376 crore invested, out of ₹17,53,070 crore in commitments across all AIFs. That figure includes private equity and real estate funds, not only credit.

Domestic managers are scaling up. JM Financial launched its second credit AIF in May 2026 with a ₹1,000 crore base size and a ₹1,000 crore greenshoe. 360 ONE closed its fifth credit fund at around US$400 million in March 2026. Kotak, Neo, InCred, Vivriti, Northern Arc, Sundaram Alternates and others run credit strategies too. Naming them is not a recommendation; it shows investors now have a real choice of managers.

Technology is changing both sides of the market:

• Underwriting. Managers increasingly use digital data and analytics to assess MSME and mid-market borrowers, where traditional data is thin.
• Monitoring. Covenant tracking relies on regular borrower data; how often a manager reviews it is a key diligence question.
• Investor transparency. AIF units sit in demat accounts, NAVs are uploaded to depositories, and half-yearly performance benchmarking against peers is mandatory for schemes more than a year past first close.
• Comparison. Online tools now let investors line up AIFs by category and strategy before speaking to a distributor.

Private credit is one of the hardest asset classes to compare, because the numbers that matter sit inside placement memoranda rather than on a factsheet. PMS Sahi Hai, which describes itself as India's first AI-powered PMS and AIF marketplace, is built to narrow that gap. Be clear about the limits too: the site does not yet carry a dedicated private credit screen or guide, so treat it as a shortlisting and question-framing tool.

• Line up Category II funds side by side. The AIF comparison shelf shows the same fields for every fund: minimum investment, AUM, returns, risk measures and a facts-and-fees panel. Where a manager has not disclosed fees or lock-in terms, the page shows a blank, not a guess. For a credit fund, each blank becomes a question from the checklist below.
• Ask Nyra the structural questions. Nyra, the platform's AI research analyst, lets you explore Category I, II or III funds by capital and investment timeline. It is grounded in SEBI, AMC and IFSCA primary sources, cites a source for every answer and declines when no verifiable source exists, which helps when checking rules such as the 25% concentration cap or the tenure extension limit.
• Read the score for what it is. Nyra rates strategies from 0 to 10 across five pillars under a published scoring methodology, and strategies with less than 12 months of track record show as "Not Rated". The score is backward-looking; it does not grade security cover, covenants or default history, so use it as a filter, not as underwriting.
• Fill the rules and tax gaps. The site's guides to Category II AIF rules, Category II taxation and TDS and internal rate of return cover mechanics this guide only touches.

Nyra is a research tool and does not give personalised investment advice; for that conversation, the team offers a private consultation.

The extra yield is real, and so are the reasons for it:

• Illiquidity. You cannot redeem. The fund runs for at least three years, often five or six, and a two-thirds majority can extend it by two more.
• Concentrated credit risk. With 15–25 loans, a single default can erase a year's excess return. Structures in India have not yet been tested through a full domestic credit downturn, a point made by managers themselves.
• Enforcement takes time. Security is only as good as the ability to enforce it. Academic commentary notes that AIF lenders have narrower enforcement options than banks, relying heavily on the Insolvency and Bankruptcy Code, and fund-manager commentary flags that enforcement can be slow.
• Yield compression and covenant drift. As more capital chases the same borrowers, spreads narrow and covenants loosen. "Covenant-lite" deals are a warning sign of competition, not innovation.
• Valuation is model-based. Unlisted loans have no market price, so reported NAVs can look smoother than the underlying risk. A stable NAV is not proof of a stable portfolio.
• Fees and tax drag. Management fees, performance fees, expenses and GST can absorb a large share of the spread, and interest income is taxed at slab rates, which for top-bracket investors can be steep.
• Manager dependence. Outcomes depend heavily on one team's underwriting discipline. A strong first fund does not guarantee the next.
• Global sentiment. In early 2026, several US semi-liquid credit funds faced heavy withdrawal requests and some limited redemptions. Indian closed-ended funds are structured differently, but the episode shows the asset class has not been through every kind of stress.

None of this makes the strategy unsuitable. It makes it a home for money you will not need for five or more years, sized as a slice of a diversified portfolio.

Take this India-specific checklist into any meeting with a manager or distributor.

1. Track record across a cycle. How many funds has the team run, and what were realised (not projected) net IRRs? Did the record include the 2018–2020 NBFC stress?
2. Defaults and recoveries. Ask how many loans stopped paying, how much was recovered, how long it took and what was restructured. "Zero losses" claims deserve evidence.
3. Gross vs net returns. Ask for the target gross portfolio yield and the target net IRR to investors, and get the fee stack that bridges them: management fee, hurdle, performance fee, catch-up, expenses and GST.
4. Borrower profile and sector mix. What revenue and EBITDA range does the fund target, and how much will go to real estate, NBFCs, or any one sector?
5. Security and covenants. What is the typical security cover, what share of loans is senior secured, and which financial covenants are standard? Ask how many current deals are covenant-lite.
6. Concentration and pacing. How many loans will the portfolio hold, what is the largest single exposure (SEBI's cap is 25%), and how quickly will money be deployed?
7. Sponsor commitment. How much is the sponsor or manager investing alongside you? One fund launched in 2024 committed up to 15% of fund size, a meaningful alignment signal.
8. Valuation and reporting. Who is the independent valuer, and what portfolio data will you receive each quarter?
9. Investor base and RBI rules. Is a bank or NBFC a large investor, or the sponsor? If so, SEBI's evergreening checks and the RBI's caps apply; ask how deals with the sponsor's own borrowers are handled.
10. Terms and exit. Tenure, extension clauses, recycling rules and what happens to loans still outstanding at maturity. Read the private placement memorandum, not just the pitch deck.

A manager who answers all ten clearly and in writing is usually more trustworthy than one quoting the highest target return.

Private credit is not a magic fixed-income substitute. It is lending: you earn more than a bond because you accept illiquidity, concentration and the chance that a borrower stumbles. Performing credit is one of its more conservative forms in India, aimed at healthy mid-market companies, structured through a regulated Category II AIF with a leverage ban, a 25% concentration limit and independent valuation.

Among the private credit funds in India, a well-run performing credit strategy suits investors who already have core equity and debt in place, can commit ₹1 crore without needing it for five years, and want contractual income that does not move with the market daily. It suits poorly anyone who may need the money early or is drawn only by the headline number.

The right question is not "what is the yield?" but "what am I being paid for, and is this manager good at managing it?" Answer that, and private credit can earn its place. If you want to narrow the field first, PMS Sahi Hai and its AI analyst Nyra can shortlist Category II funds by category and timeline before you open the first placement memorandum.

Credit funds can look alike from the outside: similar target yields, similar "senior secured" language, similar tenures. The differences that decide your outcome are inside the documents, in the manager's track record, fee stack, security structures and default history. Start by using the PMS Sahi Hai AIF comparison to shortlist two or three funds, then ask Nyra to check the rules behind each one, with a source cited for every answer. Put the ten questions above to each manager in writing, and book a private consultation with the PMS Sahi Hai team if you want a second pair of eyes before you sign. Invest only what you can leave untouched for the full fund life.