India’s remarkable economic growth has resulted in a notable increase in the country’s high-net-worth investors (HNIs). According to recent wealth reports, the population of high-net-worth individuals (HNIs) with assets worth $1 million or more, which was 7.9 lakh in 2022, will rise to 16.5 lakh, a 107 per cent increase in five years.

The growing number of HNIs, as well as their desire to diversify their portfolios and access opportunities outside of traditional avenues such as stocks, mutual funds, and fixed deposits, has prompted the innovation of existing investment products, leading to the emergence of a new asset class known as ‘Alternatives.’

Although the same principles of financial and investment planning apply to all investors, HNIs have an advantage. They can choose from a broader range of conventional and unconventional investment opportunities. Investing in unconventional avenues, such as Alternatives, can improve portfolio performance, generate alpha, and allow investors to grow their wealth faster.

Let us look at a few examples of such investment opportunities:

1.      Alternative Investment Funds (AIFs)

These funds were launched in 2012 after the market regulator SEBI issued guidelines for their management. The guidelines enable AIFs to identify and make investment opportunities available to investors in the public and private markets. AIFs, for example, can invest in listed and unlisted equities via private equity, infrastructure assets, venture debt, stressed assets, start-ups, and so on. 

As a result, the term “alternatives” came about. The guidelines have divided these funds into three categories to make it easier for investors to understand the fund’s investment objective. These categories are I, II, and III.

A noteworthy feature of AIFs is that their returns are generally uncorrelated with publicly traded equity or debt markets, providing a natural hedge against volatility and genuine portfolio diversification.

Because of the minimum investment threshold of ₹1 crore, AIFs are only available to HNIs. However, not all funds are required to collect ₹1 crore in a single transaction. They can collect the money in tranches (called drawdowns) over 2-3 years. The drawdown mechanism makes these funds easy on the wallet. AIFs have amassed an AUM of ₹8.30-lakh crore in the 11 years since their inception, demonstrating the shift of HNI money to this asset.

The following are some of the investment opportunities available only to HNIs and presented by AIFs:

a) Start-up funds: Angel investors looking to invest in ideas that have the potential to grow into full-scale businesses can do so through start-up funds, which provide a unique platform for bringing promoters and investors together. These funds handpick start-ups after extensive due diligence and build a portfolio with the potential to multiply capital several times.

b) Mid-stage private equity (PE) funds: Investors who are hesitant to take the risk of investing in start-ups can invest in companies in the middle of their evolution cycle. Their business valuations grow exponentially as they mature and enter the late-stage or pre-IPO stage. The mid-stage PE fund allows investors to participate in the growth of such companies.

c) Late-stage or pre-IPO funds: Pre-IPO funds allow investors to invest in mature companies preparing to list on the stock exchange. Such funds build a portfolio of companies about to go public and plan to exit them after their anticipated blockbuster listing, which can magnify returns in a relatively short period. Such funds gained immense popularity after the 2020 stock market rally that witnessed the blockbuster listing of some of the popular IPOs of B2C companies.

d) Hedge funds: These funds invest in both publicly traded and unlisted stocks. They manage their funds using long-only and long-short strategies, with the latter allowed to use complex derivative techniques to hedge the portfolio. The specialty of long-short funds is that they try to optimise returns in every market situation. Hence, they tend to rise and fall lower than their peers. Investors with stock and mutual fund portfolios can diversify with hedge funds to reduce volatility.

e) Performing credit funds: Many operating companies cannot raise funds from banks and NBFCs due to their size or credit ratings. This is where performing credit funds come into play. These funds specialise in credit risk assessment and, after thorough due diligence, offer credit to such companies at relatively higher rates, resulting in higher overall returns than AAA/AA-rated bonds. These funds are attractive for investors seeking higher returns on their fixed-income portfolio, which includes debt funds and AA/AAA-rated bonds.

f) Infrastructure Funds: These funds invest in long-term infrastructure assets owned by PSUs or private companies, such as roads, power transmission lines, and solar power plants. Most infrastructure projects provide essential societal services and thus have intrinsic value. These assets generate cashflows in the form of annuities backed by Central and State governments, lowering the risk of future cash flows significantly. These annuities are regularly distributed by funds to the investors, giving them the characteristic of yield. When the fund reaches maturity, the assets may be sold to another fund or infrastructure trust, resulting in capital gains in overall fund returns.

g) Venture debt funds: Start-up promoters frequently want to raise money without selling equity. As start-ups, they are unable to approach banks and mutual funds. This is where venture debt funds, which specialise in providing credit to start-ups, come in handy. It goes without saying that such AIFs help these start-ups raise funds at high rates. The higher returns of such funds and risk management appeal to risk-taking, yield-hungry investors.

The above fund list is not exhaustive but highlights some of the unique investment opportunities available to HNIs through AIFs. Many more such options are available to investors, such as special situation funds, real estate yield funds, and so on.

Along with the investment opportunities presented by AIFs, some other alternatives available to HNIs are:

2.      Portfolio Management Services (PMS)

PMS guidelines in India date back to 1993, but this investment avenue has grown in popularity with HNIs recently. The growing financialisation of savings, the formalisation of the economy, and the growing prosperity of tier 2 and 3 cities have resulted in an increase in AUM (excluding EPFO/PF), which stood at ₹5.28 lakh crore as of July 2023. Because the minimum investment is ₹50 lakh, this option is also only available to HNIs. Both PMS and mutual funds provide expert guidance in navigating volatile markets and seizing investment opportunities that help create wealth. Because mutual funds cater to retail investors, their guidelines are relatively stringent, and compliance is rigorous.

Regarding PMS, the investment guidelines are somewhat more flexible, allowing portfolio managers to outperform mutual funds. Another feature that appeals to HNIs is that the beneficial ownership of securities is that of the investors, as opposed to mutual funds, where the ownership is that of the fund. Furthermore, PMS is available in two options: discretionary and non-discretionary. In the former case, the portfolio managers make all decisions; in the latter case, the investor makes all decisions.

3.      Market-linked Debentures (MLD)

For HNIs looking to invest a part of their investible surplus in debt, MLDs can be a prudent option. MLDs are non-convertible debt instruments whose returns are tied to a specific financial market benchmark, such as the Nifty 50, the BSE Sensex, or the 10-year G-Sec. The maturity periods of MLDs can vary from one year to five years. 

Though the minimum investment for MLDs is ₹1 lakh, making it easier even for small investors to invest in them, they are more popular with the HNIs owing to the complex structure of these debentures. MLDs, unlike traditional fixed-income securities, do not provide periodic interest payments before maturity. Income multipliers and principal protection are common features of equity-linked MLDs. In the former case, the MLDs can generate a return that is a multiple of the underlying index’s return. This increases the likelihood of a higher overall return for a more minor market movement. The latter option safeguards the principal (up to the face value of the debenture) in the event of an adverse market movement. This feature allows even investors with a moderate risk tolerance to easily participate in the market.

From the discussion above, it is amply evident that HNIs have various alternative avenues to grow their wealth. The distinct value proposition of AIF, PMS, and MLDs, with unique features, distinctive risk-return profiles, and low correlation with traditional asset classes, makes them genuinely deserving of a place in the portfolio of every HNI. Before investing, investors should conduct thorough research to understand how these investment options work. It’s important to consider the past track record and management team before making investment decisions. Consultation with investment advisors who are knowledgeable in this area can undoubtedly be beneficial.

The author is President & Head, Nuvama Wealth

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