Alternative funds are good options for HNIs
They operate as go-anywhere funds, and can even short the market – something mutual funds and PMS fund managers can’t do
In the developed markets, mutual fund houses cater to retail investors, while high net worth individuals (HNIs) flock to specialised investment boutiques. That trend appears to be now playing out in India as well. Alternative Investment Funds (AIFs), which require a minimum investment of ~10 million, appear to have caught the fancy of HNIs. From a meagre ~23.58 billion on June 30, 2013, the amount committed to these funds had risen to ~1,795.85 billion by June 30, 2018.
Differentiated strategies: HNIs are gravitating towards AIFs primarily for the differentiated strategies they offer, which are not available in either mutual funds (MF) or the portfolio management schemes (PMS). Moreover, AIFs can offer strategies that are well suited to volatile market conditions. AIF regulations, for instance, allow fund managers to short, which neither MFs nor PMS can do. “In such market conditions, a long-short fund can give marketlike returns with a lower level of volatility,” says Radhika Gupta, chief executive officer, Edelweiss Mutual Fund.
AIFs also allow affluent investors to diversify their portfolios into differentiated asset classes, such as infrastructure and other high-yield debt, stressed assets, and so on. One AIF strategy that has been popular in recent times is pre-IPO funds, which invest in companies that will list within the next 6-12 months.
According to investment advisors, the category most popular among HNIs so far has been longonly, fundamental-research backed funds with a bottom-up, sector agnostic and multi-cap strategy. “Many AIFs run concentrated strategies, taking exposure only to around 15 stocks. This strategy, while being more volatile, has the potential to outperform mutual funds, which usually take more diversified bets,” says Ankur Kapur, head-investment advisory, Banyan Capital Advisors. AIFs can also take leveraged bets, which mutual funds can't.
Fund managers enjoy greater leeway: Many AIFs have been launched by stalwart fund managers, such as Sunil Singhania and Kenneth Andrade. Their star power has been a major draw for HNI investors.
With the reclassification norms being introduced by the Securities and Exchange Board of India (Sebi), mutual fund managers now have to be very straitjacketed in their investment approach. “AIFs enjoy greater flexibility since they don't have to adhere to Sebi's reclassification norms,” says Sunil Singhania, founder, Abakkus Asset Manager.
AIFs are free to take as much cash exposure as they want to when markets turn expensive, while most fund houses have internal limits. Assets under management (AUMs) of many MF schemes have crossed ~200 billion, resulting in loss of agility. “Most AIFs today have AUMs in the range of ~5-10 billion, which allows them to be nimbler,” adds Singhania. Investors even get the opportunity to interact with the fund manager of their AIFs.
The sponsors of AIFs have skin in the game “The sponsors have to invest either 5 per cent of the corpus or ~100 million, whichever is lower, in category III AIFs,” says Sachin Shah, fund manager, Emkay Investment Managers. Many sponsor-managers, in reality, have much bigger sums invested in their funds, which means that they are in the same boat as their investors. If the fund manager is also the sponsor, the chances that he will quit the fund and hop to another are close to nil.
Choose the right fee structure: Some AIFs have a fixed fee, which could range from 1-2.5 per cent. Others have a fixed plus variable (or performance linked) fee. “I prefer funds that have a low fixed fee and a high performance-linked component as this leads to better alignment of interest between the fund manager and the investor,” says Kapur.
A performance-linked fee structure comes with a hurdle rate. Once the return crosses this rate, a part of it has to be shared with the fund manager. “Usually, higher the hurdle rate, higher is the profit share of the fund manager. Opt for a fund with a higher hurdle rate,” says Sarvesh Gupta, founder, Maximal Capital and a Sebi-registered investment advisor.
Low on track record: Most AIFs were launched only recently and hence don't have much of a track record. “Since the funds don’t have a track record, the fund manager must have an outstanding record of over 20-25 years either at a mutual fund or PMS,” says Kapur.
Investors need to understand the risks of various strategies and asset classes. Says Shah: “Many investors invest in long-short funds, believing them to be safe. But these funds can witness significant drawdown within a short period.” Many AIFs are closed-end which means that investors must be prepared to lock in their money for that tenure. “The high minimum investment requirement of ~10 million makes it difficult for investors to spread their eggs across many baskets,” says VK Sharma, head-PCG and capital markets group, HDFC Securities.
Distribution commissions are high in AIFs, which could create the incentive to mis-sell. Hence choose your advisor carefully. “Go with a fee-only advisor. And if you can find one, opt for an advisor who also charges a performancelinked fee,” says Gupta of Maximal Capital. Only investors with a portfolio of ~100 million or more should invest in AIFs. Of this, only a limited portion should be invested in AIFs. “About 20-30 per cent of your portfolio should be in PMS, and another 50-60 per cent in traditional products like mutual funds, exchange traded funds, debt funds and bonds. Only about 10-20 per cent should be parked in AIFs,” says Kapur. With the markets having corrected considerably, value is beginning to emerge in the equity markets. “Those with a five year plus kind of horizon may invest in long only, fundamentalsdriven AIFs in a staggered manner, if their existing exposure to equities is low,” says Gupta of Maximal Capital.