 "Track record of fund manager most relevant")
Since Alternative Investment Funds (AIFs) were permitted to operate in India, they have been witnessing a steady inflow of money. High networth individuals (HNIs), always on the lookout for more investment options they can bet on in the quest for higher returns and for diversification of their portfolio, are the ones who have primarily invested in these. As on June 30, the total commitments raised by Securities and Exchange Board of India (Sebi)-registered AIFs were Rs 50,441 crore, compared to Rs 38,878 crore in the earlier quarter.
AIFs offer an asset class that is different from the basic equity, debt or hybrid products offered by mutual funds (MFs) and Portfolio Management Services (PMS). Meant for only HNIs, who can invest Rs 1 crore and above. It offers a variety of options that include venture funds, social venture, private equity funds, real estate funds, infra venture funds, hedge funds, equity and equity related funds and so on. Today, there are about 200 Sebi registered AIFs, across Categories I, II, and III.
"Somebody who wants to invest in a higher risk category of debt, in the unlisted equity space, or wants to operate in the risk profile that is somewhere between equity and debt, cannot do so through MF or PMS,'' says Arvind Bansal. head of products & advisory, Avendus Wealth Management.
The AIF regulations came out in 2012 and brought in transparency for investors, ensured sponsor commitment from fund managers, complete adherence to fund objectives and also brought tax clarity to some extent, says Sunil Goyal, founder and chief executive of YourNest Angel Fund.
Vaibhav Sanghavi, managing director, Ambit Investment Advisors, says globally, alternative investments account for 13-15 per cent of investors' portfolios. In India it is currently nil. So, the scope is huge. Ambit has a Category III AIF, which manages assets of Rs 1,100 crore.
Category I and II are closed-ended funds, with eight to 10 years period. None of them have started paying returns. Category III AIFs are open-ended funds and are more suitable for regular liquidity. "It is normal to expect a five-year plus period for returns. If held for a longer period, it can give 19-20 per cent kind of returns,'' says Goyal. But, keep in mind a few things.
How many exits: One must check not only if fund managers have raised and deployed funds but also if they have returned money to investors. "Valuation is part of market conditions to a certain extent. But, one must check if the fund manager has returned money to investors and given an exit opportunity,'' Bansal adds.
Strategy of the fund: The uniqueness of the strategy is important, especially in the case of a Category III AIF, says Nishant Agarwal, senior director and head-products, investment advisory and family office solutions, ASK Wealth Advisors. It should also be aligned to your risk profile and investment objective, adds Goyal. "Since Category III is not the best platform from the tax point of view, unless the strategy is really unique and not available from other avenues like MF or PMS, you should avoid it. Fees are higher in AIF and the fee structure is more complex. So, it should complement your portfolio and not duplicate something that is available in a simpler, straightforward manner,'' Agarwal says.
AIF vs direct investing: Why should HNIs, who also have the ability to invest directly, pay fees and invest through fund managers? The biggest advantage is the professional service a fund manager provides and the pooling of assets. "Direct investment in equity requires constant monitoring. There is no professional manager or accountability. That is easier when left to fund managers. Or in the case of real estate, through AIFs you can invest in multiple projects or properties, as against locking your money in a single property as an individual investor,'' Agarwal explains.
Fee structure: Some AIFs charge fixed fees, while some have a profit-sharing model. In case of profit sharing, a hurdle rate is fixed for the returns. Once the returns cross that hurdle, the fee is charged as a percentage of the additional profit. For instance, if the hurdle is fixed at 10 per cent and the fund generates 20 per cent returns, the fee is a percentage of the additional 10 per cent profit. Some funds charge profit sharing with catch-up. This means that once the hurdle is crossed, the fee is charged as a percentage of the entire 20 per cent return, instead of the additional 10 per cent. "Some investors do resist the catch up option, but fee structure is still evolving and fees are market determined,'' says Bansal.
Taxation: One issue that need to be addressed is the taxation for Category III AIFs. Both Category Iand Category II AIFs have pass-through taxation, that is, the returns are taxed in the hands of investors. But, in the case of Category III it is taxed in the hands of the fund. This causes a lot of complexities and confusion, says Sanghavi.
Some hygiene rules: As a thumb rule, don't invest all your money in one year. Stagger it over a period of time because you may make the investment in a bullish year but if the fund's exit is in a bad year, your returns will be hit. "Keep on investing year after year and invest with different managers, so you get time diversification and manager diversification also,'' says Bansal. Goyal adds that it is important to speak to the fund managers and interact with them before investing to understand the objective of the fund.
AIFs offer an asset class that is different from the basic equity, debt or hybrid products offered by mutual funds (MFs) and Portfolio Management Services (PMS). Meant for only HNIs, who can invest Rs 1 crore and above. It offers a variety of options that include venture funds, social venture, private equity funds, real estate funds, infra venture funds, hedge funds, equity and equity related funds and so on. Today, there are about 200 Sebi registered AIFs, across Categories I, II, and III.
"Somebody who wants to invest in a higher risk category of debt, in the unlisted equity space, or wants to operate in the risk profile that is somewhere between equity and debt, cannot do so through MF or PMS,'' says Arvind Bansal. head of products & advisory, Avendus Wealth Management.
The AIF regulations came out in 2012 and brought in transparency for investors, ensured sponsor commitment from fund managers, complete adherence to fund objectives and also brought tax clarity to some extent, says Sunil Goyal, founder and chief executive of YourNest Angel Fund.
Vaibhav Sanghavi, managing director, Ambit Investment Advisors, says globally, alternative investments account for 13-15 per cent of investors' portfolios. In India it is currently nil. So, the scope is huge. Ambit has a Category III AIF, which manages assets of Rs 1,100 crore.
Category I and II are closed-ended funds, with eight to 10 years period. None of them have started paying returns. Category III AIFs are open-ended funds and are more suitable for regular liquidity. "It is normal to expect a five-year plus period for returns. If held for a longer period, it can give 19-20 per cent kind of returns,'' says Goyal. But, keep in mind a few things.
How many exits: One must check not only if fund managers have raised and deployed funds but also if they have returned money to investors. "Valuation is part of market conditions to a certain extent. But, one must check if the fund manager has returned money to investors and given an exit opportunity,'' Bansal adds.
Strategy of the fund: The uniqueness of the strategy is important, especially in the case of a Category III AIF, says Nishant Agarwal, senior director and head-products, investment advisory and family office solutions, ASK Wealth Advisors. It should also be aligned to your risk profile and investment objective, adds Goyal. "Since Category III is not the best platform from the tax point of view, unless the strategy is really unique and not available from other avenues like MF or PMS, you should avoid it. Fees are higher in AIF and the fee structure is more complex. So, it should complement your portfolio and not duplicate something that is available in a simpler, straightforward manner,'' Agarwal says.
AIF vs direct investing: Why should HNIs, who also have the ability to invest directly, pay fees and invest through fund managers? The biggest advantage is the professional service a fund manager provides and the pooling of assets. "Direct investment in equity requires constant monitoring. There is no professional manager or accountability. That is easier when left to fund managers. Or in the case of real estate, through AIFs you can invest in multiple projects or properties, as against locking your money in a single property as an individual investor,'' Agarwal explains.
Fee structure: Some AIFs charge fixed fees, while some have a profit-sharing model. In case of profit sharing, a hurdle rate is fixed for the returns. Once the returns cross that hurdle, the fee is charged as a percentage of the additional profit. For instance, if the hurdle is fixed at 10 per cent and the fund generates 20 per cent returns, the fee is a percentage of the additional 10 per cent profit. Some funds charge profit sharing with catch-up. This means that once the hurdle is crossed, the fee is charged as a percentage of the entire 20 per cent return, instead of the additional 10 per cent. "Some investors do resist the catch up option, but fee structure is still evolving and fees are market determined,'' says Bansal.
Taxation: One issue that need to be addressed is the taxation for Category III AIFs. Both Category Iand Category II AIFs have pass-through taxation, that is, the returns are taxed in the hands of investors. But, in the case of Category III it is taxed in the hands of the fund. This causes a lot of complexities and confusion, says Sanghavi.
Some hygiene rules: As a thumb rule, don't invest all your money in one year. Stagger it over a period of time because you may make the investment in a bullish year but if the fund's exit is in a bad year, your returns will be hit. "Keep on investing year after year and invest with different managers, so you get time diversification and manager diversification also,'' says Bansal. Goyal adds that it is important to speak to the fund managers and interact with them before investing to understand the objective of the fund.