Alternative investments are increasingly becoming mainstream. Thanks to their low correlation to public markets, alternative investment funds (AIF) are emerging as the preferred investment route for high networth individuals (HNIs) and family offices, who seek higher risk-adjusted returns and diversification from traditional equity, debt and other asset classes.

As per SEBI data, the total assets of AIF, on a year-on-year basis, jumped 38 per cent to ₹6.09-lakh crore as of December 2021 from ₹4.42-lakh crore in the year ago period. The growth rate was even higher than the entire mutual fund industry, whose assets grew 22 per cent to ₹37.91-lakh crore from ₹31.02-lakh crore during the comparable period. Total assets of AIF were only ₹3.70-lakh crore as of March 2020.

Privately pooled investment vehicle

Structured similar to mutual funds, AIF is a privately pooled investment vehicle that collects money from sophisticated private investors from India and overseas and invests them as per a defined investment policy. AIF has a minimum investment limit of ₹1 crore.

There are three categories of AIF. Category II, which constitutes over 80 per cent of the total AIF assets, grew 40 per cent year-on-year to ₹4.95-lakh crore as of December 2021, from ₹3.53-lakh crore as of December 2020.

“Category II comprises private equity funds, pre-IPO funds, real estate funds, structured credit funds and venture debt. In the last 12-18 months, while real estate funds have not done very well, all the other segments have seen a fair amount of demand for growth,” said Vishal Chandiramani, Managing Partner- Products & COO, TrustPlutus Wealth.

“If you take PE or pre-IPO funds, there has been an increase in appetite. Thanks to the awareness of investing in companies at an early stage or pre-IPO to make multiple returns. The run-up in the equity market, the number of unicorns emerging in the last few years has also influenced the demand for this category,” Chandiramani added.

Asheesh Chanda, Founder & CEO, Kristal.AI, said given the volatility in markets and an anticipated rising rate environment, a strong interest in this category is expected to continue. “In private market funds, private equity and venture cap funds are also becoming a perma allocation for this class of investors, which provide an un-correlated source of returns albeit, with more illiquidity.”

Chandiramani said the low interest returns from debt mutual funds and FDs have also pushed HNIs towards structured credit funds, which is a portfolio of NCDs and debt instruments of listed and unlisted companies, which typically don’t qualify for bank loans. These are high risk and high return instruments.

“Venture debt is also similar to structured credit funds but here they lend debt to early stage companies so the risk is higher than structured credit funds, the returns are also higher in the range of 16 per cent,” Chadiramani, said, adding, “So, HNIs look at structured credit and venture debt given the low interest in the economy, low returns on high quality instruments.”

Short-term returns

Category III AIF focuses on earning short-term returns through diverse or complex trading strategies and includes hedge funds and private investment in public equity (PIPE) funds. Assets under this category grew 36 per cent, year on year, to ₹63,699 crore as of December (₹46,825 crore).

While Category I & II AIF are passthrough vehicles, which means tax has to be computed and shown in the books of investors. In case of category III AIF, taxation is at a fund level. Since the investors get only post-tax returns, they need not worry about showing tax on their books.

“From an ease of convenience, a lot of HNIs started liking tax free long only funds (category III) as opposed to PMS which has a lot of taxation and other issues,” Chandiramani said.