William J Kelly
Any investment not made in bonds, stocks, and cash may be considered an alternative investment. Investments in real estate, private equity, land, venture capital, intellectual property, and equity long-short strategies are all examples of alternative investment.
Across India, there are three categories in which alternative investments may be made.
Investments in SME Funds, in Infrastructure Funds and Social Venture Funds, and in Venture Capital Funds, are classified under ‘Category 1’. Funds in ‘Category 1’ invest in economically and socially desirable ventures.
Private Equity Funds and Debt Funds fall are classified under ‘Category 2’ Alternative Investment Funds.
An alternative investment that doesn’t fall in ‘Category 1’ or ‘Category 3’ may be clubbed in ‘Category 3’.
‘Category 3’ funds employ complex and diverse investment strategies that take on higher levels of risk in an effort to earn higher than average returns.
Funds in the third category may use leverage and invest across different investment products. Hedge Funds, for instance, fall in Category 3. Today, over 520 Alternate Investment Funds (AIF) are registered with SEBI.
SEBI’s decision late last year to allow Alternate Investment Funds to operate from International Finance Services Centre (IFSC), Gift City, is an effort to bring the AIF industry onshore from places such as Mauritius and Singapore.
The new platform for AIFs at IFSC allows private equity investors to launch funds at marginal cost. AIFs launched from IFSC will be dollar-based, making them convenient to Indians wanting to make offshore investments.
Investing in Infrastructure, Venture Capital, and SME funds
India is developing rapidly and its leaders and people have global aspirations. The fulfillment of these global aspirations demands the construction of world-class infrastructure across the country.
Better roads, bridges, airports, railways, and ports are essential to meet national aspirations and also to fuel the economy.
Over the next several years the country needs to invest as much as $1.5 trillion in physical infrastructure to grow the economy.
It is against this backdrop that Infrastructure Funds are financing the construction of infrastructure across India.
Home to approximately 7,200 startups, India has a vibrant startup ecosystem in which investments can be made through Venture Capital Funds.
A large number of Indian startups are creating efficiencies and bringing about lasting behavioural change in society. While Indians slowly grow accustomed to using the services of disruptive startups and their lives synchronise to the services provided by startups, risks of failure will remain high. However, some of these startups are to likely create lifelong customers and earn attractive returns for investors.
The Government of India established the National Investment and Infrastructure Fund Limited (NIIFL) in 2015 to invest in domestic infrastructure and take advantage of the growth just over the horizon.
In effect, funds such as the NIIFL will align the interests of investors with the ambition of the nation.
Much of urban India is undergoing a behavioural change fuelled by startups. From companies encouraging consumption of fresh foods to food delivery and ride-hailing apps, all are changing habits, preferences, and lifestyles of Indians.
Venture Capital funds capitalise on the growth trajectory of the Indian startup ecosystem and behavioural changes that permeate the Indian society.
The venture capital space in India also has government backing in the form of frameworks that institutionalise it. Such institutionalisation gives investors clarity about the structure, process and due diligence of investments in startups, and making investing in Venture Capital Funds attractive.
The recent government decision to ease norms for startups including exemptions for AIFs that invest in startups, makes Venture Capital funds even more attractive.
Medium-sized enterprises are heavily traded on Indian exchanges. SME Funds have been established to take advantage of such trading.
Because of the relatively high volatility of SMEs, investing in SME funds is suited to the less risk-averse among investors.
Private Equity funds: poised for growth
Private Equity (PE) in India has come of age. An investment in private equity is likely to see greater growth than one did in earlier periods.
The spectacularly high exits made in 2017 and 2018 highlight this. In 2017 Private Equity funds received investments in excess of $26 billion, while exits from investments stood at $16 billion.
Globally private equity manages nearly $3 trillion. India’s share in global private equity is minuscule, and private equity in India attracts investors because of the economy’s growth trajectory and the wealth of investors, which is growing.
Private Equity funds are not investment vehicles for the unsophisticated. Only a fraction of Indian investors, less than 0.01 per cent, can invest in private equity because such investments demand significant capital and financial astuteness.
The risk appetite and sophistication of many wealthy Indians cannot be accommodated by the stock market. It is such Indians, hungry for higher returns, who take the private equity route.
In 2018 the scope of private equity was plainly seen when PE exits, helped by Walmart’s purchase of Flipkart, topped $25 billion.
Global institutional investors are already attracted to private equity in India because of recently introduced structural reforms including the Goods and Services Tax and the Bankruptcy Code.
As the Indian economy grows, individual wealth grows, and expertise of Indian firm’s blossom, more investors may gravitate to investing in PE funds.
Hedge funds: at a nascent stage
Hedge funds are a new investment vehicle in India, but suffer because of an unfavorable income tax regime that taxes Hedge funds gains at the fund level. The income tax laws in India have failed to define hedge funds.
After Private Equity funds, Venture Capital funds and Real Estate funds, Hedge funds are the most popular AIF in India. Because some Hedge funds are expected to generate returns in both rising and falling markets, or provide risk premiums that are not correlated to the public equity markets, Indian investors with higher risk appetites are attracted to them.
While not the most popular AIF, the promise of returns in falling and rising markets or lower overall portfolio volatility through diversification make Hedge funds attractive.
A more favourable tax regime to govern Hedge funds is likely to increase their attractiveness. Investing in stocks is widespread across India, and millions of retail investors have capital invested in Indian browsers. To some wealthier, astute investors, AIFs may be ideal instruments.
Certainly, one of the most important reasons to invest in AIFs is the low correlation of different classes of AIFs with other investment vehicles and each other; this presents significant opportunities to hedge.
As India’s AIF ecosystem gains global prominence, its goal of presenting sophisticated investors with opportunities to protect or grow wealth beyond what is possible through traditional investments, may be realised.
Patience and informed consent are the hallmarks of what defines success for most things in life, and investing is certainly not an exception.
Due diligence and education are extremely important, and every investor, either on their own or through the services of a trusted advisor, should approach any investment with full understanding of whether their expectations are in alignment with the underlying risks that they are taking on.
Diversification across asset classes that are not correlated is not a straight-forward exercise, as performance dispersion gets very wide in many alternative offerings.
Target allocations to the broad buckets of hedge funds, private equity, and venture capital in the absence of thorough due diligence, are likely going to disappoint most investors.
Finally, a long-term view of your investment plan is essential.
The most successful investors are the ones who keep an eye on the distant horizon by remaining fully invested across a diverse set of risk premia, paying less attention to the interim and inevitable sharp edges of volatility.
Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.