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The growing popularity of AIFs
For several years, people have been investing their money into traditional public equities and debt securities. A concern from an investor’s point of view while putting their money in public equities is that the market is very volatile and it is difficult to achieve the first mover advantage, while the burden of tax remains a constant woe. The desire for earning greater returns have started to shift investor’s attention to alternative asset classes. Alternative Investment Funds (AIFs) have witnessed a significant interest from investors in India. AIFs invests in a variety of asset classes including private equity, venture capitals, hedge funds, real estate, etc. by privately pooling the investors money. There are about 700 AIFs in India worth over INR 4 Tn in investments. Growing interest in such investment options has resulted in an impressive growth of 15x since 2015. Cumulatively, AIFs received investments amounting to INR 1.6 Tn, as of September 2021. With Indian markets witnessing a high growth and super speed at which startups are gaining unicorn status in India, such alternative classes are expected to be helpful in accelerating the investors’ return.
AIF pools money from sophisticated investors or HNIs, whether Indian or foreign. They can choose from 3 categories, depending on their preferences.
- Category I – This category invests in social venture funds, SMEs, Infrastructure funds,etc which are considered socially and economically desirable by the regulators.
- Category II – These include those funds that do not leverage or borrow, other than to meet the daily operational requirements. For example real estate funds, private equity, debt funds, or funds for distressed assets, etc.
- Category III – Funds within this category usually involve diverse or complex trading strategies, such as investments in hedge funds. It may employ leverage through investment in listed or unlisted derivatives.
Source: SEBI, Cumulative net figures as at the end of March 31, 2021
According to SEBI reports as of March 2021, out of the three categories, Category II has received the most amount of investments of about INR 1.4 Tn, where total amount for AIFs as whole is estimated to be over INR $2 Tn. Looking at the CRISIL AIF Benchmark report data, a positive trend is witnessed in the returns, particularly for category II and category III funds. Some of the best performing AIF providers in India are – Abakkus Asset Manager, Roha Asset Managers, Grik Advisors. Their one-year returns are much higher than the CRISIL Benchmark.
Source: CRISIL Alternative Investments Fund Benchmark Report, September 2020
How can alternatives complement a traditional portfolio?
While traditional investments cannot completely vanish from the scene, alternative asset classes offer a better compliment to the conventional investments as it allows investors to diversify their funds, while earning better returns. As a result, investors can add alternatives to their portfolios and it would enable them to earn better, risk adjusted returns. The type and proportion of investments into different assets depends on individual to individual, on the basis of their preferences. Also, It is important that investors consider reshuffling their portfolio from time to time, according to the changing market conditions.
Why Invest in Alternatives?
Diversifying one’s portfolio in alternative asset classes helps in minimizing the risks of the investors as returns are less volatile. This helps investors in achieving their long term financial goals. Even though AIFs may carry higher levels of risks, it provides higher returns compared to conventional asset classes as it is not directly linked with the stock market. As a result, it can increase the value of the portfolio. For instance, investing in Category II of AIFs can offer double-digit returns through venture debt and also allows participation in equity upside, with the fixed return component.
With high growth businesses and booming markets, India is attracting investors’ attention from all over the world. While it is comparatively new, AIFs can provide a great alternative for high networth individuals. Returns from AIFs will continue to rise as the startup ecosystem in the country is at an all time high and shows no sign of slowing down.
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This article has been co-authored by Tamanna Kapur, who is in the Research and Insights team of Torre Capital.