What does the sharpest rise in risky AIFs mean?

AIF is a privately pooled investment vehicle that requires a minimum investment amount 1 crore (this is 25 lakhs for a venture capital fund) that provides access to unconventional asset classes such as private equity, pre-IPO funds, hedge funds or ordinary funds that boast of high alpha-generating capabilities. These funds are covered under the AIF regulations of the Securities and Exchange Board of India (SEBI).

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What does the sharpest rise in risky AIFs mean?

About 56% of the 881 AIFs as of March 2022 were registered with SEBI in the past four years, according to Crisil. “Awareness about the AIF investment product has grown manifold over the years. A big driver for this was Franklin Templeton’s debt fund crisis (when the AMC suddenly closed some debt funds in 2020 due to redemption pressure), which resulted in credit becoming part of the AIF sector. The other big contributor has been the low interest rate regime across the world, resulting in an alternate flow of funds in search of higher yields,” said Vineet Sukumar, founder and managing director of Vivritti Group.

Unprecedented growth in the AIF industry, which is accessible only to High-Net-Worth Individuals (HNIs) and Ultra-High-Net-Worth Individuals (UHNIs) with minimum ticket sizes. 1 crore in most cases, raising the question whether this is an indicator of rising income inequality in the country.

To put this in perspective, the mutual fund industry, a favorite of retail investors, grew at about 16% CAGR in the said period.

Of course, the low base of the AIF industry makes the growth figures alternatively inflated. stood on Assets Under Management (AUM) of the Mutual Fund and AIF industry 38.4 trillion and 6.4 trillion respectively by FY22 (see table),

The Category II AIF space attracted significant interest with a major chunk of capital allocated to this segment which includes private equity funds, real estate funds and debt funds. The range is said to offer the maximum level of customization and innovation in an alternative space for HNIs and UHNIs looking for.

For the uninitiated, AIF comes in three different categories. Category I funds invest in startups or early stage enterprises. Category III funds such as hedge funds employ diversified or complex trading strategies for investing in listed or unlisted securities/derivatives. These funds are permitted to leverage (borrow) subject to specified conditions. Category II is a residual category that does not fit into Category I or III.

Rising credit requirement from mid and small-cap companies and drying up of funding from NBFCs (Non-Banking Financing Companies) also lead to rapid growth of private credit funds within category II funds. Vikas M Sachdeva, Managing Director, Sundaram Alternatives said, “AIFs to meet the unmet credit needs of medium and small-sized companies and provide long-term funding to AIFs to contribute to the structural growth of AUM in the private credit space.” Help is on the way.” ,

Delivered Results?

These funds form a significant portion of the assets under management of AIFs as a result of investors’ willingness to take higher risks with startups and the unlisted equity space.

According to Crisil AIF Benchmark Research, Venture Capital Funds (Category I) have outperformed public market indices – S&P BSE 500 TRI over the three- to five-year period till FY2021, with an average outperformance of 20 percentage points Used to be. The performance of Unlisted Equity Funds (Cat II) has been mixed, ranging from almost zero to marginally outperforming the market – for those who take risk. Long-only equity AIFs in Category III could not prove their outperformance during the same period, which raises questions about the high fees and low tax efficiency that come with these categories of funds.

Note that AIF benchmarking in India is still in its infancy and due to the diverse nature of the investment theme pursued by each AIF, there is a possibility of combining similar-to-identical funds while taking the category average.

Also, according to CRISIL, most AIFs are yet to complete their life cycle and distribute a major portion of their portfolio. The attractiveness of the AIF space can only be gauged in the coming few years when many AIFs will be moving towards the end of their life cycle.

Crisil’s Jiju Vidyadharan and Piyush Gupta, who have written a new report on the investment industry, said, “The ability of fund managers to exit their portfolio companies in a timely manner at favorable valuations will be a key factor that will determine an AIF investor’s experience.” . Will happen.”

Income inequality?

Saurabh Mukherjee, founder, Marcellus Investment Managers, believes that the growth in the stock market/AIF space is a manifestation of the polarization of the Indian economy around a few efficient companies in each sector.

“As corporate profitability polarises with the closure of 7-8 lakh small businesses every year, there is an acceleration of formalization of the economy and market share in the hands of a few companies in every sector. This results in both income and wealth inequality in our country,” Mukherjee said.

However, he believes that India is following a fairly classical economic cycle. “Economic growth around the world, including other Asian economies, is generally associated with rising inequality up to $10,000 per capita income. India is on its way to the $10,000 mark and thus, we are living through income inequality ,” They said.

Nikhil Kamath, co-founder of Zerodha and True Beacon, which owns both PMS and AIF funds, says, “Any suggestion that India’s booming AIF sector has been affected by rising income inequality is a reflection of India’s socio-economic and would be a misrepresentation of the financials. landscape. As an emerging economy with a nascent financial sector, the growth in Indian AIFs reflects an increased appetite and ability among middle class citizens to participate in their country’s economy due to regulatory relaxations. In addition to a growing middle-class investor base, the growth of the AIF sector also reflects a demand by its wealthiest citizens – most of whom were already involved in the financial markets – to take advantage of these more sophisticated investment strategies that are now available. are available to them. While wealth inequality is a real and growing problem in India, the growth of the AIF sector should not be considered a sign of the problem, but part of the solution.”

Other experts also believe that the growing AIF industry may not be a sign of income inequality. They believe that this is a reflection of the upgrading of the middle class to the upper middle class due to economic progress, but not at the expense of the lower-income group.

Leaving aside income inequality, many members of the third and fourth generations of family businesses are investors in the venture capital space of AIFs. It is an entrepreneurial asset that is creating more jobs in the economy, resulting in economic growth,” said Munish Randev, Founder and CEO, Cervin Family Office & Advisers.

the road ahead

The AIF space is expected to grow at a healthy pace in the coming years, with various initiatives from the industry and the regulator such as digital onboarding, AIF benchmarking and the introduction of an accredited investor framework.

Based on the 2022 survey by the Indian Association of Alternative Investment Funds (IAAIF), investors are keen to increase alternative allocation in their overall portfolio by around 5-10 percentage points in the coming years.

Industry players desire certain modifications in the existing ecosystem to see further traction in the AIF space. The Accredited Investor Framework comes with several benefits which include the flexibility to participate in AIFs with investment amounts less than the mandated minimum amount. 1 crore. “The concept is well thought out, but the current framework is very rigid. It could really deepen the market if executed well,” said Sukumar.

In the IAAIF Survey 2022, Apoorva Vora, Founder and CEO, Finlutions LLP, pointed out that AIF has become a very common term. “You can have an AIF that aims to be on par with or slightly better than a liquid fund compared to an aggressive AIF dealing with distressed assets. Unfortunately, both are classified as AIF. For the end investor, this can be challenging to understand. Firstly, industry leaders should talk about the classification of AIFs on the basis of risk and asset class. This will help in bringing more investor confidence and will also help the money managers.”

Further, the survey also pointed out that 100% of the respondents desired rationalization of taxation of Category III AIFs. Currently, Category I and Category II AIFs have tax pass-through status for Indian income tax purposes. This means that investors are taxed on income from investments made by AIFs as if the investments were made directly by them. For Category III AIFs, tax is generally paid at the fund level depending on the legal structure of the AIF.

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