India is on the cusp of an unprecedented investment and wealth creation phase, and alternative investment funds (AIFs) are emerging as the vehicle of choice for ultra- and high-net-worth individuals (HNIs and UHNWIs), according to the IVCA-Eleveight Category III Alternative Investment Fund Report 2024.
Category III AIFs, known for their innovative approach and diverse range of investment strategies, have seen a surge in new fund launches in FY24. "Category III AIFs in India are at the forefront of financial innovation, presenting a diverse array of strategies including long-only, long-short equity, absolute return, market neutral, arbitrage, and credit," says Vikas M Sachdeva, Managing Director of Sundaram Alternate Assets Ltd, in the report. These funds aim to deliver superior risk-adjusted returns and are poised to secure a significant share of investor portfolios, shaping the future of HNI investment in India.
Agrees Anshu Kapoor, President and Head of Nuvama Asset Management. "Category III AIFs herald a new era of product innovation, providing investors access to a spectrum of previously unavailable, differentiated solutions to diversify their portfolios, manage volatility, and generate consistent returns," he says in the report.
What are CAT III AIFs?
These funds employ diverse or complex trading strategies and may use leverage through investments in listed or unlisted derivatives. The report highlights that these funds are designed to hedge risks effectively, enabling the creation of all-weather portfolios and optimising risk-adjusted returns.
The report projects that commitments raised by Category III AIFs could grow to Rs 2.5 lakh crore by 2028, with top players planning to raise at least Rs 60,000 crore over the next two years. This growth is attributed to several factors, including rising income levels, increased investor awareness, and regulatory reforms.
The growing wealth and the increasing number of wealthy individuals in India are identified as key drivers for the growth of AIFs. "While a host of factors are conflating to boost industry growth, one of the key drivers has been the growing wealth and the number of wealthy in the country," the report states. This segment of investors has nuanced portfolio requirements, some of which can be optimally catered to by AIFs.
Dominant Strategies
Within the Category III AIFs, two strategies primarily dominate the offerings: long only and long short. Long-only funds, accounting for about 61% of the CAT III share, offer concentrated exposure to specific sectors or stocks, promising high-quality selection by fund managers. "Long-only AIFs enable fund managers to adopt a concentrated approach to generate potentially better returns and extend their industry knowledge to serve more sophisticated customers," says the report. Long short strategies, constituting about 38% of CAT III AIFs, cater to investor demand for absolute return and hedge fund strategies.
Wealth managers play a crucial role in the AIF ecosystem, acting as intermediaries between fund managers and investors. They educate investors, introduce them to new offerings, and help them choose the most suitable products based on their risk-return profiles.
Challenges and the Road Ahead
The report identifies taxation as the most significant challenge facing CAT III AIFs. The lack of pass-through taxation, limited awareness among distributors, and the perception of high risk among investors are other hurdles.
To overcome these challenges, the report suggests several regulatory changes, including providing tax pass-through status to Category III AIFs, sub-categorizing them, and simplifying the accreditation process for investors. It also emphasises the need for increased investor education and standardised communication practices.
GIFT City: A Rising Hub
The report highlights the rise of GIFT City as a thriving hub for alternative investments, attributing its success to its robust regulatory framework and tax incentives. The number of funds in GIFT City has doubled since April 2023, underscoring its growing prominence in the AIF landscape. Ravi Vukkadala, CEO of Northern Arc Investment Manager, says in the report, "This, combined with the progressive regulatory atmosphere in the country, not only promises better pricing but also fosters an environment conducive to sustainable growth, driven by demand from investors and product innovation by manufacturers."
