aif Provide access to non-traditional asset classes such as venture capital (VC) funds that invest in early-stage startups, unlisted equity funds that invest in growth stage or pre-IPO companies, and hedge funds that invest in listed equities Deploy complex trading strategies. space. Since these are risky investments, market regulator SEBI has mandated a minimum investment of 1 crore in AIF.
Investors’ willingness to take higher risk with startups and the unlisted equity space, which constitutes a significant portion of assets under management of AIFs, has fueled the rapid growth of the industry over the years. These funds, in particular, venture capital AIF funds, generate significant alpha (see table) in comparison to broad market indices in India, despite the high risk.
On the other hand, long-only equity funds underperformed. This raises questions on the high fees and low tax efficiency this category of funds fall under.
The above performance analysis is based on CRISIL AIF benchmark research, which reported the category average returns of AIFs as on 30 September 2021. For benchmarking, CRISIL has divided the entire AIF industry into seven sub-categories based on asset type and strategy. invests in the fund. Note that AIF benchmarking in India is still in its infancy and due to the diverse nature of the investment disciplines adopted by each AIF, comparison of like-to-like funds is unlikely.
However, given that benchmarks give an insight into how investments performed on an average basis, we recommend CRISIL – Venture Capital Funds (part of Category I AIFs), Equity Funds – Unlisted (part of Category II AIFs) designed by Let’s look at the performance of the three benchmarks made. ) and long-only equity funds (Category III AIFs).
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unlisted equity position
Generally, the venture capital fund category includes funds that invest in early-stage technology businesses. Due to the close-ended nature of most AIFs in Category I and II with different entry and exit points, the fund’s performance in such categories is evaluated on a ‘vintage year’ basis.
The vintage year is the financial year in which a scheme made its first investment in simple words. If the first investment was made between 1st April 2014 and 31st March 2015, its vintage year would be the vintage FY15. Now, the performance of venture capital funds for the previous year of FY20 is the Annual Internal Rate (IRR) of all funds that infused in FY15.
Venture capital funds outperformed the public market index — the S&P BSE 500 TRI — by 8-27 percentage points in four of the seven past years, according to Crisil’s analysis.
For the same old period, the performance of unlisted equity funds, however, has been mixed with an outperformance of 3-4 percentage points in two of the seven previous years.
Still, the wealth managers and family offices Mint spoke to are very positive about investing in the unlisted equity space—both the venture capital and unlisted space.
“The confidence to invest in the unlisted AIF space comes from India’s macroeconomic growth story, solved by great entrepreneurs and the best teams for it. The AIF industry is also maturing. Sandeep Jethwani, Co-Founder, Deserve, said, “There are good fund managers with a track record of professionally managing funds, which are also regulated by SEBI.
Wealth managers believe that the benchmark averages the returns that the fund delivers across the category and points to the importance of selecting a good fund manager.
According to Munish Ranadeo, Founder and CEO, Cervin Family Office & Advisors, most of his clients started investing in venture capital and unlisted equities in the earlier years of FY2015 to FY2017 and are yet to exit. He believes that the expected returns on those investments so far are in the range of 25-40% IRR.
Experts also believe that timing of investment in the unlisted space matters in generating optimum returns. “Investment in the unlisted sector should be treated like a SIP (Systematic Investment Plan) of mutual funds,” said Jethwani. You cannot invest all your money in one year. If investors have 100, I strongly encourage them to invest 20 every year for the next five years. That way, they don’t catch a single bad cycle.”
On the total allocation to unlisted stocks, Rupali Prabhu, Chief Investment Officer, Sanctum Wealth said, “Our suggestion to clients is to invest 10-15% in the unlisted space. The break-up between a venture capital fund and a growth fund depends on the risk tolerance of the investor. Companies in the growth stage have less risk of death and thus the risk of investing in such companies in Category II funds is low. Obviously, they may not make the returns they could have earned by investing in VC funds. But this is a risk-reward trade-off.
Ashish Fafdia, partner, Bloom Ventures, one of the largest Indian venture funds, said he is convinced that this is not a product for retail investors. “Investors need to understand that it is a liquid investment and should remain invested for at least 6-8 years. The investment provides good diversification to the portfolio, but both the fund manager and the investor need to be sophisticated and educated to get the most out of it,” said Fafdia who also represents the Indian Private Equity and Venture Capital Association.
Apart from venture funds and unlisted equity funds, there are also long-only Category III AIFs. These invest in the listed equity space and are comparable with actively managed equity-oriented mutual funds and PMS.
The only difference is that the former can use leverage (borrowing) to maximize profits. Sankaranarayanan Krishnan, Quant Hedge Fund Manager, Motilal Oswal Financial Services, says the opacity of the portfolio that AIFs offer is its biggest strength.
Wealth managers, however, do not feel that this category can offer much to investors or fund managers.
The CRISIL Benchmark states that on the basis of gross returns, AIFs have not outperformed the broader market index or the category average of diversified flexi-cap MFs. Note, the market segment-large, mid and small cap exposure by these funds may vary.
“Even as per the rolling return analysis of actively managed MFs, PMSEs and Category III listed equity AIFs in the last three years, MFs are delivering better risk-adjusted returns,” Jethwani said.
Randev holds the same opinion and said that his firm avoids investing in long-only equity funds as they are less tax-efficient. He said, “There are few tax leakages in long-term equity AIF funds as compared to mutual funds. Since AIFs are taxed at the fund level, they have to pay capital gains tax every time they trade, whereas an MF is taxed only in the hands of the investor at the time of redemption. Also, the overall fees for AIF are higher as compared to PMS.”
According to the analysis of Crisil’s report, investing in a good VC fund would have yielded good risk-adjusted returns over the past few years. Benchmark returns representing the average performance of the category show meaningful alpha in comparison to the broader equity market indices. The performance of unlisted equity funds in the Category II bucket till September 2021 was mixed. Even at present when market sentiment is low, wealth managers believe that investors can consider investing in the VC/unlisted equity space.
On the other hand, long-term equity AIFs in Category III could not prove their outperformance. In the long term, it would be better for investors to invest in diversified MFs or PMS.
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