Of risk and return

News that a group of NRI investors are suing the ICICI group because they lost money in a venture capital fund run by it questions fundamental assumptions about high-risk investment vehicles and the affluent who invest in them. Until now, the Securities and Exchange Board of India (SEBI) has been adopting a ‘light-touch’ approach to framing rules for venture funds, presumably because of the belief that high networth investors are well-informed, or at least well-advised, and therefore capable of looking after their own interests, unlike small retail investors. But the facts of this case suggest otherwise. 

Dynamic India Fund III was a seven-year capital fund for NRIs to invest in Indian real estate projects. During its launch, investors allege, the fund used the track record of previous schemes to indicate a return of 25 per cent per annum. But nine years later, by March 2014, 12 out of 13 projects in the portfolio remained incomplete. Aggrieved investors are now seeking damages of $103.7 million based on the promised return, apart from accusing the fund of selecting poorly managed projects. They also charge that the fund failed to inform them about the status of these projects all these years. Given that the Indian real estate sector has gone from unbridled optimism to an extended slump in the last six years, most funds as well as real estate IPOs launched in the boom years of 2005 and 2007 have lost money. Thus, it may be quite difficult to prove that this fund lost money due to its negligence or the failure to invest in ‘world-class’ projects, as the investors allege. It is also surprising that high networth investors were so naïve as to be taken in by the promise of a 25 per cent return. After all, venture capital is among the most risky classes of equity investment and execution delays are endemic to real estate, making such a fund doubly risky. But even so, the complaints about the fund’s failure to provide investors with the mandatory offer document at launch, the lack of regular portfolio updates and concerns about concentration could well merit SEBI’s attention.

SEBI’s regulations governing the filings, disclosures and fee structures for venture capital funds are far less stringent than those for retail vehicles like mutual funds. For instance, mutual funds are subject to a 10 per cent exposure limit on each stock, a daily valuation of their portfolios, monthly portfolio disclosures and fixed caps on fees. But venture capital funds are left more or less free to decide on such things. The venture capital industry needs to seriously introspect if wealthy clients deserve a better deal on disclosures, returns and fees than they are presently getting. SEBI, on its part, needs to re-examine its basic assumption that affluent investors are inherently market-savvy.

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