In the part I of the article, we got an overview of the alternative investment funds (AIF) industry and magnitude of its growth since inception. In this part II of the article, let us understand more about each category funds, prominent players, taxation and further opportunities for the industry.
Industry experts believe that the size of AIF industry is likely to double over next two to three years supported by increasing number of wealth investors, family offices and favourable policies by the regulators. We have seen the amount of funds raised double in the past year. Among the three categories of AIF, category III seems to be receiving major preference from investors fuelled by the long – short funds which are new to Indian markets.
This phenomenal growth has happened in a mere span of five years. Mutual funds and Portfolio Management Services (PMS) took much longer to gain such traction. Apart from mutual fund houses, many players like Piramal, Avendus Capital, Old Bridge Capital have ventured in to this space.
Prominent Players and Funds in Each Category
Category I AIF: This category includes Startup Funds, Venture Capital Funds and Infrastructure Funds. Orios Venture Partners, Zodius Venture Capital, Blume Ventures, Kae Capital & IDG ventures are some of the key venture capital firms while infrastructure fund space is dominated by companies like Edelweiss Asset Management, Larsen & Toubro & Piramal.
Edelweiss launched one of the largest fund in this category, the Edelweiss Infrastructure Yield Plus fund in mid December’2017 with a target of raising Rs 2,000 crore. This fund marked 1st closure of raising money on 31st March with Rs 2,000 crore and plans to raise additional Rs 4,500 crore over a one year period. Fund has a life span of 10 years and intends to deploy assets in three years with an average holding period of five years.
Category II AIF: This category includes Real Estate funds, Pre-IPO funds, Private Equity Funds and Debt Funds (structured credit). In the real estate space players like Aditya Birla Group, ASK, HDFC Bank & ICICI Bank have their funds. Faering Capital, Gaja Capital, KEDAARA Capital are few of the marquee names in private equity space. Structured credit space is dominated by fund houses like KKR, Indostar Capital Finance and the pre-IPO space is dominated by players like IIFL & Edelweiss.
IIFL has made a significant mark through its pre-IPO fund, IIFL Special Opportunities Fund series first launched in 2017. The strategy is to invest in companies before they are listed, participating in IPOs through QIB route and investing post IPO through QIP, FPO, preferential allotment, buy back & merger. Year 2017 was a golden year for Indian IPO market with several insurance companies such as General Insurance Corporation (GIC) and ICICI Lombard, exchanges such as the BSE and the Indian Energy Exchange (IEX) going public. IIFL Special Opportunities Fund Series 7 closed recently and the total fund size through various series stands at ~Rs 8500 crore.
Category III AIF: Hedge Funds, funds with diverse strategies & funds focusing on generating absolute returns are included in this category. This category hosts differential strategies like Long Only Fund (benefiting through long term equity growth), Long–Short: Debt & Long-Short: Equity (benefiting from long term growth as well as short term correction).
Apart from big payers like Aditya Birla Group, IIFL Asset management, Motilal Oswal, Edelweiss, Avendus many other asset managers are offering these funds; Old Bridge Capital, Malabar Capital, Redart India, and Narnolia are few notable players.
Avendus launched its Avendus Absolute Return Fund in 2017 and raised Rs 2,300 crore. With an aim to generate absolute returns with lower volatility than the stock market, the fund invests in listed equities and equity derivatives. The strategy takes long positions in equities in the cash market and short positions through futures & options across different market scenarios. Following the huge success of this fund, they launched a second fund named Avendus Enhanced Return Fund which adopts a mix of long only and long-short strategies.
Franklin Templeton Alternative Investments recently launched a category III AIF called the Franklin India Long Short Equity AIF. The fund is led by Sundaresan Nagnath who was earlier President and Chief Investment Officer (CIO) at DSP BlackRock.
Category I & category II AIFs benefit from pass-through taxation i.e. tax will not be deducted at the fund level and all income (excluding income from business or profession) will be passed on to investors. The funds withhold tax at 10% for resident investors and for non-resident investors it will depend upon the applicable tax rates as per tax treaty. However, any losses made by the funds are not eligible for pass through and are allowed to be carried forward at fund level to be set off against future gains. The industry lobby is in talks with the Finance ministry to allow losses to be passed on too.
Category III AIF’s are taxed at the fund level and do not enjoy the benefit of pass-through taxation. This is a major hurdle that has limited the growth of this category and discussions are on for unit based taxation of Category III funds.
RupeeIQ Take: Sophisticated and savvy investors in India currently have multiple options ranging from mutual funds to PMS and AIFs. We believe as the economy develops the markets will mature, leaving very little room for incremental alpha generation. In such scenarios, niche strategies are likely to deliver better performance. AIFs have an advantage over PMS and mutual funds because they can adopt complex strategies and can make use of derivatives and leverage which otherwise is not available to mutual funds and PMS providers. However, the industry is yet to see a full cycle and we recommend investment in AIFs from a portfolio diversification point of view. Investors can allocate a minor portion of their assets to AIFs.