AIFs log 60% growth in one year on the back of easier regulatory framework

Inflows into Category-III AIFs may taper because of the higher rate of taxation
Investments in alternative investment funds (AIFs) — typically targeted at wealthy investors — have grown 60 per cent to Rs 1.19 trillion in the past year, on the back of easing regulatory framework and increasing investment in the debt space.

The growth has been led by Category-II AIFs, which has seen investments made surge 79 per cent to Rs 74,816 crore at the end of June 2019. Investments made in Category-I and Category-II AIFs have risen 31 per cent and 37 per cent, respectively.

Category-I AIFs invest in start-up or early-stage ventures, social ventures, small and medium-sized enterprises, infrastructure or other sectors, which the government or regulators consider as socially or economically desirable.

Real estate funds, private equity funds, and funds for distressed assets, among others, are registered as Category-II AIFs. AIFs that employ diverse or complex trading strategies and use leverage through investment in listed or unlisted derivatives come under Category-III.

“High net worth individuals (HNIs) and family offices are increasingly allocating a certain portion of their wealth to AIFs. Alternatives provide an opportunity to invest in unlisted companies that could include new-age sectors and start-ups, especially in the consumer and tech space,” said Ashish Shanker, head–investments, Motilal Oswal Private Wealth.  

He added that there was a lot of interest seen in structured debt transactions on the AIF platform, including distressed and real estate debt. This was a key reason for the growth of Category-II AIFs, he said.  

Earlier this year, the likes of InCred Capital, KKR, and JM Financial had filed for regulatory approvals focused on the debt segment.

Inflows into Category-III AIFs may taper because of the higher rate of taxation that will be applicable to these funds. Long-short funds that do derivatives trades and earn ‘business income’ will see their tax rate increase to 42.7 per cent, from 35.9 per cent earlier, if income earned exceeds Rs 5 crore.

“We have already started seeing redemptions in this category,” said Shanker.

Some of these funds are now toying with the idea of restructuring to limited liability partnerships or registering anew in GIFT City, a tax-friendly zone, to avoid paying the higher surcharge.

Mutual funds (MFs) are also upping the ante in the AIF space, with an aim to diversify their offerings and tap into a niche client pool. Franklin Templeton MF, for instance, launched its Franklin India Long Short Equity AIF late last year.

Unlike MFs, AIFs can invest in the unlisted space and deploy long-short strategies, with no compulsion to hedge portfolios. They can play concentrated bets and make private investment in public companies.

With the emergence of passive products and the increase in efficiency of the Indian market, generating alpha will become difficult for fund managers in the coming years, reckon experts. This is where AIF strategies will gain currency. “There is definitely a market for these products,” said Kaustubh Belapurkar, director, fund research, Morningstar Investment Adviser India. According to him, MFs can target these products at HNIs willing to take higher risks and wanting to invest in the unlisted, real estate, and debt space.

AIFs are privately-pooled investment vehicles established or incorporated in India that collect funds from sophisticated investors — whether Indian or foreign.

Besides providing for a pass-through to Category-I and -II AIFs, the government brought about several other changes in the past few years. For instance, the holding period for availing of long-term capital gains in investments made by AIFs in the unlisted space was reduced to two years, from the earlier three years. The one-year lock-in period for AIFs after initial public offerings has been done away with.

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