Alternative Investment Funds (AIFs) have emerged as a viable and lucrative investment option for High Networth Individuals (HNIs) in India. In the past few years, AIFs have become increasingly popular among investors seeking diversification beyond traditional asset classes like stocks, bonds, and mutual funds. With over 1,250 AIFs launched in India since 2012, and an estimated asset base of $45 billion (as of March 2021), these funds have shown tremendous potential to grow wealth for HNIs.
AIFs can be an amazing avenue for HNIs due to several factors. Firstly, the investment horizon of most AIFs is significantly longer than that of equity or debt mutual funds. This gives investors the opportunity to reap the benefits of compounding returns over the long term. Secondly, AIFs often invest in sectors with low correlation to the equity market, thereby helping investors mitigate risks and improve their portfolio's diversification.
Furthermore, Indian AIFs have also outperformed traditional assets in recent years. A 2023 report by Business Standard based on SEBI data revealed that Alternative Investment Funds (Category I and II) outperformed both equity mutual funds and the broad market benchmark Nifty 50 in the past year. Category I AIFs delivered an average return of 18.2%, while Category II AIFs generated an average return of 14.5% compared to the Nifty 50's 8.4% and equity mutual funds' average return of 10.2%.
The Allure of AIFs for HNIs
HNIs are constantly seeking investment avenues that align with their risk appetite, return expectations, and long-term financial goals. AIFs offer several advantages that make them an attractive proposition for this investor segment:
Diversification: AIFs provide access to a wide range of asset classes and investment strategies, enabling HNIs to diversify their portfolios and mitigate risk.
Superior Returns: AIFs have the potential to generate superior returns compared to traditional investments due to their ability to invest in alternative asset classes and employ sophisticated investment strategies. For example, Accel Partners' Fund VII delivered a 5x return on investment within four years, and in the case of PE funds, True North's India Value Fund III achieved a 3.6x IRR with exits from companies like Myntra and Pepperfry.
Tax Benefits: AIFs offer certain tax benefits, such as pass-through taxation and exemption from capital gains tax under specific conditions.
Professional Management: AIFs are managed by experienced investment professionals who possess specialised knowledge and expertise in alternative asset classes.
Types of AIFs in India
The Securities and Exchange Board of India (SEBI) categorises AIFs into three primary types, each with distinct investment objectives and strategies:
Category I AIFs: These AIFs invest in a diversified portfolio of assets like Start-ups, Early-stage, high-growth potential companies, typically in their seed or Series A funding rounds and Small and Medium Enterprises (SMEs) which can include established businesses with significant growth potential, looking for expansion or capital for specific projects.
Category II AIFs: Also known as Private Equity (PE) Funds, Category II AIFs invest in unlisted equity shares and debt instruments of companies with high growth potential. They are suitable for HNIs with a higher risk appetite and the ability to withstand short-term volatility.
According to the SEBI, the AIF industry in India has witnessed a remarkable growth in recent years. The total AUM of AIFs has grown from ₹5.63 lakh crore in March 2018 to ₹18.86 lakh crore in March 2022, representing a CAGR of 30.6%. PE Funds have been the major contributor to this growth, accounting for over 60% of the total AUM. This reflects the growing interest of HNIs in private equity investments.
Category III AIFs: These AIFs invest in alternative assets such as hedge funds, real estate investment trusts (REITs), infrastructure projects, and commodities. They are suitable for HNIs with a sophisticated understanding of alternative asset classes and a high tolerance for risk.
Category 3, AIFs employ diverse or complex trading strategies across derivatives, securities, and even other AIF units. They are allowed to leverage up to 2 times their fund corpus, amplifying potential returns. They also have an open-ended or closed-ended structure (minimum 3 years for closed-ended) and a high barrier to entry with a minimum ticket size of Rs. 1 crore. In all the 3 categories, this category is also the one which allows earning through shorting a stock. In addition, they are subject to stricter reporting requirements due to leverage usage.
A study by Bain & Company and the Indian Private Equity and Venture Capital Association (IVCA) revealed that PE/VC investments in India generated a return of 12-15% over the past decade, outperforming traditional asset classes such as equity and debt.
Deeper Look at Some AIFs:
Venture Capital Funds: These funds primarily invest in early-stage and growth-stage companies, with a focus on technology, healthcare, and consumer sectors. Venture capital funds in India have performed remarkably well, with over 1,000 startups receiving investments from these funds over the past decade. According to data from venture capital firm Venture Intelligence, the aggregate value of exits made by Indian venture capital-backed companies grew from $2.9 billion in 2012 to $43.3 billion in 2021. This trend signifies the immense potential of the Indian startup ecosystem and suggests that venture capital funds can be a great source of wealth creation for HNIs.
Private Equity Funds: Private equity funds invest in unlisted companies or take over listed companies with the aim of improving their operations and selling them at a higher price in the future, delisting them in the process. These funds have been particularly successful in India, with many PE-backed companies achieving multi-billion dollar valuations in recent years. For instance, PE firm Carlyle Group's investment in Jubilant FoodWorks Ltd., which operates Domino's Pizza franchises in India, has grown over 20x since 2006. This illustrates the potential for private equity funds to deliver strong returns for HNIs.
Hedge Funds: Hedge funds use complex investment strategies to generate returns irrespective of market conditions. In India, hedge funds have primarily focused on arbitrage and market-neutral strategies, which have helped them achieve attractive risk-adjusted returns. According to data from hedge fund research firm Eurekahedge, the Indian hedge fund industry has grown at a CAGR of 22% from 2010 to 2020, with assets under management reaching $15.2 billion in 2020. This growth highlights the potential of hedge funds to add diversification and generate superior returns for HNIs
The Gist
Alternative Investment Funds (AIFs) offer HNIs in India an avenue for portfolio growth and diversification. With their ability to invest in a wide range of asset classes, generate superior returns, and provide tax benefits, AIFs have become an increasingly popular choice among sophisticated investors. By understanding the different types of AIFs and their investment strategies, HNIs can make informed decisions and leverage AIFs to achieve their long-term financial goals.
Investing in AIFs is not just about numbers and returns; it's about venturing beyond the ordinary, embracing innovation, and unlocking the hidden potential of untapped markets. For HNIs who dare to break away from the conventional and chase ambitious financial goals, AIFs present a powerful tool not just for wealth creation, but for shaping their financial legacies. The question then remains: are you ready to chart your own path in the world of alternative investments?
Comments