Alternates – An Alternate to Traditional Investing

Investing is an essential part of life and is an effective way to put your money to work to build potential wealth. Investing helps to beat inflation thereby resulting in real wealth creation and having a portfolio made over time as a retirement plan. “Buy not on optimism, but on arithmetic,” said Benjamin Graham who is known for his investing style and contribution to literature on investing and research.

In today’s era, there are avenues for an investor to consider parking their monies. Below mentioned are a few areas of investing:

1. Equity such as stocks, mutual funds, PMS, NPS, etc.
2. Debt or fixed income such as debentures, mutual funds, Structured products, Fixed Deposits, PF/PPF, Kisan Vikas Patra (KVP), etc
3. Real Estate
4. Gold
5. Alternates

Each of these asset classes has its pros and cons and it would be ideal to evaluate them individually by synchronizing with our investment goals.

While equity, debt, real estate, and gold have been avenues for a long time now, Alternates as an asset class is fast rising in India. The AUM of the AIF (Alternative Investment Fund) industry stood at ~6.5 lakh crore as of 2021-22 compared to the Indian equity mutual fund AUM, which stood at ~23 lakh crore. This exhibits the potential and growth opportunities in this investing segment.

Deep Dive to AIF space In India

AIFs are privately pooled investment vehicles that collect funds from investors and invest in a variety of assets, which are different from traditional investment avenues like stocks and bonds. Briefly, in this article we look at the journey of AIFs in Indian market.

The Securities and Exchange Board of India (SEBI) regulates the AIF industry in India and has established a comprehensive regulatory framework for AIFs back in 2012, which includes registration requirements, investment restrictions, and reporting obligations.

Categories of AIFs: SEBI has categorized AIFs into three categories based on their investment strategies and objectives:

1. Category I: These funds invest in start-ups, small and medium-sized enterprises (SMEs) – angel and VC funds, social ventures, and infrastructure projects.
2. Category II: These funds include private equity funds, debt funds, and funds for distressed assets.
3. Category III: These funds engage in trading activities and use complex investment strategies like hedge funds.

Investor Eligibility: AIFs in India are open to both domestic and foreign investors. However, certain categories of AIFs may have specific investor eligibility criteria and minimum investment requirements.

Zero to One story of AIFs:

Post the introduction of the structured framework by SEBI, in the initial years from 2012 until 2015, the industry witnessed moderate growth. AIF managers started launching funds across various categories, including private equity, real estate, and infrastructure.

Around 2016, the AIF industry gained momentum, driven by favourable regulatory reforms,increasing investor interest and a growing start-up ecosystem. Several new AIFs were launched, attracting significant investments from domestic and international investors.

The AIF industry in India experienced a surge in venture capital and start-up funding during this period, 2018 – 2019. Consequently, SEBI introduced new AIF categories in 2019 and relaxed certain investment restrictions to further facilitate the growth of the industry. This led to an expansion of AIF offerings, including funds focused on distressed assets, debt financing, and trading strategies.

Why should an investor consider an Investment into Alternates?

 Some of the reasons which one could consider investing to Alternates/AIFs:

• Diversification: AIFs provide an opportunity to diversify investment portfolios beyond traditional asset classes as mentioned above. Diversification helps to reduce the overall investment risk.
• Higher Potential Returns: These assets have potential to generate higher returns compared to traditional investments. The median average return for an early growth investment range anywhere between 25%-30% IRR during the tenure of the fund. AIFs targeting niche sectors or strategies can offer attractive risk-adjusted returns. Since the most common preference of any investor is to invest at low valuations and thereby take advantage of the upside, investment into a business early in the day may ensure good valuations.
• Access to Unique Investment Opportunities: AIFs provide access to investment opportunities that may not be readily available to individual investors. For instance, AIFs focused on start-ups or venture capital can invest in promising early-stage companies with innovative business models like deep tech, AI, gaming etc.
• Professional Management: AIFs are managed by experienced fund managers or investment teams with specialized expertise in their respective sectors. Investors can benefit from the knowledge and experience of fund managers, particularly in complex or specialized investment areas.
• Potential for Cash Flow and Income Generation: Certain AIFs, such as real estate funds or debt funds, can generate regular cash flow or income through dividends, rental income, or interest payments. This can be beneficial for investors seeking a steady stream of income or those looking for capital preservation along with returns. Long term returns of a VC fund are usually generated either by a portfolio company going public or by an M&A Deal.

On an overall basis, while at times benefits might outweigh risks in certain cases, vice versa also is a plausible scenario. It is important to note that investing in AIFs involves risks, including the potential for loss of capital, illiquidity, and regulatory risks. Investors should carefully evaluate the fund’s strategy, track record, fees and associated risks before making investment decisions.

Going forward  – What makes India resilient to Global headwinds?

Looking at the growth statistics around the AIF and the fact that India is contributing ~5% of global VC funding itself a tangible proof that Indians are increasingly driven towards this sunrise space in investing.

These below mentioned factors are contributory in nature towards enhancing the spirit of entrepreneurship and encouraging people to create disruption in their respective spheres.

• India has the largest middle-income population in the world at ~370 million which is further expanding. This creates a large consumption headroom.
• Several factors continue to drive digital innovation, e.g.: UPI for payments, ONDC for commerce, Ayushman Bharat for Health.
• Monetary and fiscal policies have been effective enough to enable control over inflationary growth.
• The shift in global economic activity from China towards India because of favourable economic policies are accelerating momentum in sectors like electronics, textiles, pharma, etc.

In conclusion therefore, investing in the alternative investment fund industry presents a unique opportunity for individuals and institutions alike to diversify their portfolios and potentially achieve attractive returns. However, it is crucial to note that alternative investments come with their own set of risks, compliance, and complexities and hence one needs to be cognizant of what the investment entails for him/her.

 

Sources:

• SEBI AIF Regulations 2012 FAQs
• Bain Digest India Venture Capital Report 2023
• E&Y Report on the Media & Entertainment Sector – April 2023.
• Economic Times Article dated 19th April 2023.
• MoneyControl Article dated 13th January 2023.
• Harvard Business School – Business Insights