AIFs set to lead HNIs towards private market investment opportunities

The opportunity to expand the risk-return mix across asset classes has made alternative investment funds (AIFs) a viable proposition for family offices and high net worth investors (HNIs). In fact, there is a clear appetite among investors towards portfolio diversification and better returns beyond the traditional equity and debt classes. This optimism is driving investments in the AIF sector and has turned them into an alternative investment asset class.

According to SEBI (Securities Exchange Board of India) data relating to the activities of AIFs as on 31st December 2021, the total assets of AIFs have increased 6.09 trillion in Q3 FY22. From 5.35 trillion in Q2 FY22. From a year-on-year perspective, this is an increase of 38% from total AIF assets in Q3 FY21, which 4.41 trillion.

The tendency of investors to invest beyond traditional investments has also strengthened the growth outlook of AIFs. As per PMS market report, the net worth of AIF structures will likely be higher 50 trillion in the next 10 years. AIF has indeed emerged as an effective investment tool for wealth creation due to the availability and standardization of detailed information on AIF structures.

Since AIFs are not related to the stock market, they help investors reduce volatility. With strong diversification and inflation hedging, the potential for return in AIFs is higher than in traditional investment avenues.

Due to the uncertainty and volatility in the domestic equity markets, family office and HNI investors are scaling up their investments in a way that provides better returns on their low-yielding fixed income portfolios. Thanks to intelligent investment strategy, AIF credits can generate additional alpha through strategic asset allocation in AIFs.

The AIF route ensures the sponsors’ “skin in the game” by interlinking the interests of sponsors, investors and fund managers. The convenient structure of investment instruments considers liquidity preference through escrow of cash flows and non-core asset monetization. Since AIFs invest strategically through timely intervention in a portfolio of companies, the benefits of diversification, risk mitigation, and opportunistic return maximization are achieved by the pool.

The reason AIF is gaining traction among HNI investors is that such investments are guided by a team of experienced bankers, equipped with the skills required for origination, domain experts, and an experienced investment committee. Equipped to mitigate manageable risk, thus ensuring excellent returns. Consistent with relative convenience and safety, AIFs can be an excellent investment option for generating relatively high returns.

Among all the categories of AIFs, Category II AIFs are generating maximum interest from the investors. As per the cumulative net data as on 31st December 2021 released by SEBI, the total assets of Category II were 4.95 trillion, accounts for 81% of the total assets of 6.09 trillion. Category II AIFs investments have seen a year-on-year growth of 40% in Q3 FY22 over Q3 FY22, which stood at 3.52 trillion.

Category II AIFs include real estate funds, private equity funds (PE funds) and funds for distressed assets, which reduce the risk profile by providing a diversified investment portfolio. As a result, these AIFs are considered a defensive investment option and an effective hedging mechanism.

Credit AIFs, on the other hand, offer ease of investment due to the pooling of capital, which can defer set-up, under-writing, due diligence, legal documentation and high costs involved in fund administration. Apart from being isolated from the volatility of equity markets, investments by credit AIFs are generally secured with an asset cover of 1.25-3.5x the addition of other equity collateral. Credit AIFs can offer returns in the range of 14-15%.

Awareness of AIFs is gradually increasing among family offices and HNIs in India, cementing the potential for eventually exploring this volatility-hedging investment avenue. According to the Private Market Monitor report released by TRAICA, there are more than 140 formal family offices in India. The growing acceptance of AIFs will prove to be a major driver of private market investment opportunities for HNIs and UHNI capital allocation.

Nirmal Gangwal is the Managing Partner at Brescon & Allied Partners LLP.

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