AIF investments: An alternative that you may tread on with caution

Does this happen to you? When your investment manager recycles and repeddles the same old bank deposit/mutual fund/government bonds investments ideas, do you wish for an alternative? An option that lets you park your money in an instrument that is structured and run by professionals, but lets you invest in a more focused manner, hopefully with good returns?

Alternative investment funds (AIFs) could match your requirements. This instrument not only allows you to diversify your portfolio and follow a more focused investment strategy, but also offers attractive returns. The last, though, is dependent on various factors.

What are AIFs?

As the name suggests, these are alternatives to conventional investment instruments such as deposits, debt securities and stocks. AIFs privately pool funds from investors — both Indian and foreign — and then invest them in avenues such as venture capital (VC) funds, private equity (PE) funds, hedge funds, angel funds and managed futures. In managing the pooled corpus, the funds follow a well-defined investment policy.

The Securities and Exchange Board of India (SEBI) classifies AIFs into three categories:

• Category I AIFs cover funds that the government considers socially/economically viable/desirable, and therefore offers incentives (such as easier regulations and tax sops). These include angel funds, VC funds (early-stage and start-ups), social venture funds, infrastructure funds and SME (small and medium enterprises) funds.
• Category II AIFs are ‘residual’ funds that fall under neither of the two other categories. These cover PE funds, debt funds, and funds for distressed assets, and are the largest category of AIFs in India.
• Category III AIFs go for diverse — and complex — trading strategies and employ leverage, including investment in listed or unlisted derivatives. ‘Leverage’ refers to the use of borrowed funds to increase one’s trading position. This category covers hedge funds and PIPE (private investment in public equity) funds.

Small investors, big dreams

As with all high-risk high-returns instruments, such as Portfolio Management Service (PMS), AIFs are typically targeted at high-networth individuals (HNIs). But, of late, Indian regulators have been reining in AIFs with stricter rules and sharper monitoring. While the fund houses are trying to push back, the increased regulation is seen to encourage smaller investors to put their money is AIFs.

“In the hierarchy of investments, AIFs rank as a sophisticated one,” TR Somasundar of Shilpa Associates, a Bengaluru-based advisory firm that manages over ₹120 crore of MF assets, told The Federal.

What works for AIFs is that they are highly focused on specific sectors or geographies, and are run by professionals who’re often veterans in their respective fields. Investors have a larger say in how the monies are invested, vis-à-vis MFs.

As against MFs and direct equity investments, AIFs are also subject to fewer regulatory rules in India, which a good fund manager can utilise to benefit investors.

If you’re an HNI with funds to spare, a young investor willing to take some risk, or a seasoned investor with a canny eye for a good investment, AIFs may be for you.

“AIFs are flexible investment vehicles, and hence even common investors who are knowledgeable and not happy with ordinary returns can look at them,” said Somasundar. However, he urged caution, saying: “They better go through some sophisticated wealth managers who are specialised in this.”

For the ‘angel’ in you

Not all investments are about the highest returns. You may want to invest in sectors that you strongly believe in, like, say, green energy or rural industries. Else, you may want to invest in a fund that’s focused on the broader social sector. And there are start-ups run by bright young minds that you’re convinced will do well, and wish to be a part of. In such cases, too, AIFs are an attractive option.

Here, angel investment funds, social VC funds and infrastructure funds (infra development can make a remarkable difference to under-developed pockets and communities residing there) may be ideal.

“Angel investment is for those investors who can understand a project or a company or an individual promoter, and are willing to take a high risk in return for multibagger returns,” Somasundar told The Federal. “Wealthy or ordinary, participation in these require an entrepreneurial bent of mind.”

While you may or not aspire for brilliant returns, you would surely not want your money to go kaput. Consider a good fund manager at the helm a prerequisite when you plan your investment. “One may note that AIFs in India have underperformed the NSE returns generally,” cautioned Somasundar.

On matters regulatory

What gives AIFs an edge is perhaps what works against it, too — the lighter regulatory hand. Until recently, these funds, which basically invest in unlisted and illiquid securities, were governed by very few rules. While this meant wealth often multiplied impressively, there were also shocks aplenty.

So, now, SEBI is increasingly tightening AIF norms. For starters, it has set mandatory investment sizes. All categories of AIFs in India require a minimum individual investment of ₹1 crore, except angel funds, where the cut-off is ₹25 lakh. The fund on the whole should have a minimum corpus of ₹20 crore; for angel funds the corpus minimum size is ₹10 crore.

Also, each non-angel AIF can have only up 1,000 investors. Angel funds can each have up to 49 investors. AIFs are barred from making public appeals to investors for subscription, which explains why we never see TV/newspaper advertisements for them.

SEBI vs fund houses, and what this means to you

Earlier this week, SEBI said all AIFs looking to raise money should ideally hire investment bankers to oversee the private placement memorandum (PPM) — the document summarising the fund’s background, investment strategy, etc.  Large funds handling crores of investor money are submitting PPMs that are either incomplete, or do not conform to regulations, or both, the regulator pointed out. A professional i-banker would spot the gaps and make sure they’re addressed.

PE and VC funds are opposing the move, saying an i-banker may not necessarily understand the nuances of the scheme. AIF products are bespoke, and do not fit into tight traditional regulatory baskets, they argue.

Whether or not the proposal — coming on top of several other regulations that SEBI has already implemented — is formalised, AIFs are bound to be more tightly regulated henceforth.

It’s a double-edged for you as an investor — while your money will probably be ‘safer’, it may not make the kind of astronomical returns you had in mind.