Sebi's diktat for AIF benchmarking may lead to sub-categorisation

The Securities and Exchange Board of India’s (Sebi’s) diktat for benchmarking the performance of alternative investment funds (AIFs) may necessitate the creation of sub-categories.

Sebi has classified AIFs into three categories, with four sub-categories for ‘Category I AIFs’ that include venture capital funds (including angel funds), SME funds, social venture funds, and infrastructure funds. There are no sub-categories for category-II and category-III AIFs.

“For data to be dissected meaningfully, sub-categorisation is required,” said a senior industry executive.

All category-III schemes, for instance, are not comparable and cannot be put under one basket as they include debt, equity, and hybrid schemes with long-only or long-short strategies. Equity schemes, in turn, could be large- or mid- or small-cap oriented.

In 2017, Sebi had categorised MF schemes, defining 10 categories for equity funds, 16 for debt funds, and six for hybrid funds. The sub-categorisation of AIFs could be far more complex. Separate categories for realty, commodity funds, sector funds, mezzanine funds, and special situation funds may have to be created, said experts.

Subramaniam Krishnan, partner at EY India, said performance benchmarking will enhance transparency and aid in comparison across similar strategy schemes.

“The key will be effective stratification of AIFs into relevant and well-defined categories, such as special situations funds, mezzanine funds, real estate funds and sector funds, so that the performance of a particular fund and the benchmark are truly comparable,” he said.

AIFs employing diverse/complex trading strategies and using leverage — including via investment in listed or unlisted derivatives — are category-III and include hedge funds and PIPE funds. Those not using leverage and not falling under categories I and III are classified as category-II, and may include realty funds, PE funds, and stressed asset funds.

“Performance benchmarking will be useful if the report contains benchmarking on various criteria such as sector and stage of investment. Additionally, the data used for this benchmarking should be robust and the agency should provide clearly defined valuation policies for investments, especially in the unlisted space,” said Vaneesa Agrawal, founder of Thinking Legal.

Globally, there aren’t too many benchmarking guidelines for AIFs, according to experts. Besides, the data provided to independent agencies is done voluntarily and not as part of a regulatory diktat.

“How a benchmarking agency will process data while ensuring accuracy and completeness, and factor in variations in different kinds of AIFs under the same category (for enabling realistic comparisons) remains to be seen,” said Tejesh Chitlangi, senior partner at IC Universal Legal.

Sebi has proposed that an association of AIFs, with representation from at least 51 per cent of the industry, select one or more benchmarking agencies. The agreement between the agencies and AIFs should cover the mode and manner of data reporting, specific data that needs to be reported, and terms of confidentiality.

Benchmarking will apply to all schemes that have completed at least one year from the date of ‘First Close’. Funds incorporated overseas with India track record shall also provide data to agencies when they seek registration as AIFs.

Performance benchmarking shall be done half-yearly, based on data as of September 30 and March 31 each year. The reports are to be made available latest by July 1, 2020, for performance up to September 30, 2019.

Category-III records rise

Despite adverse tax treatment, category-III funds have seen a 14 per cent sequential rise in commitments in the December quarter.

Over the year-ago period, commitments raised are up 18 per cent and investments up 29 per cent. Experts say the surge is due to inflows in long-only funds. Long-short funds continue to remain unattractive, except for funds generating decent alpha net of taxes. These funds do derivatives trades and earn ‘business income’, and remain impacted by the surcharge hike introduced in the 2019 Budget. Such funds have seen an increase in tax rate to 42.7 per cent from 35.9 per cent, if income earned exceeds Rs 5 crore. 

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